Price‐to‐Earnings Ratios and Option Prices

Ansley Chua, Jared DeLisle, Sze‐Shiang Feng and Bong Soo Lee

Journal of Futures Markets, 2015, vol. 35, issue 8, 738-752

Abstract: In May of 1997, in the midst of the Internet bubble, the average month end P/E ratio for the software industry was 44. However, the 5‐year historical average was 31. In this study, we examine the effect of this industry value fluctuation on the effects of option prices. We examine the relationship between the level of relative valuation and option pricing via deviations in put‐call parity and a two‐factor option pricing model incorporating relative valuation. We find support that the increase in relative industry valuation Granger causes put‐call parity deviations, implying investors price options with greater expectation of downward movement. Additionally, we develop a model and find support that the two‐factor option pricing model that incorporates relative industry valuation prices options better than the standard Black–Scholes (1973) model. © 2015 Wiley Periodicals, Inc. Jrl Fut Mark 35:738–752, 2015

Date: 2015
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