The Favorite-Longshot Bias in S&P 500 and FTSE 100 Index Futures Options: The Return to Bets and the Cost of Insurance

Robert G. Tompkins, William T. Ziemba and Stewart D. Hodges
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Robert G. Tompkins: Hochschule fiir Bankwirtschaft, Germany
William T. Ziemba: Sauder School of Business, UBC, Vancouver, Canada and Mathematical Institute, Oxford University, UK and ICMA Centre, University of Reading, UK
Stewart D. Hodges: School of Business, University of Warwick, Coventry, UK

Chapter 22 in Calendar Anomalies and Arbitrage, 2012, pp 503-522 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractThis chapter examines whether the favorite-longshot bias that has been found in gambling markets (particularly horse racing) applies to options markets. We investigate this for all options on the S&P 500 futures and the FTSE 100 futures for the 17+ years from March 1985 to September 2002. Calls on the S&P 500 with both three months and one month to expiration display a relationship between probabilities and mean returns that are very similar to the favorite bias in horse racing markets. There are slight profits from deep in-the-money and at-the-money calls on the S&P 500 futures and increasingly greater losses as the call options are out-of-the-money. For three-month and one-month calls on the FTSE 100 futures, the favorite bias is not found, but a significant longshot bias has existed for the deepest out-of-the-money options. For the put options on both markets, and for both three-month and one-month horizons, investors overpay for all put options as an expected cost of insurance to protect against downside risk. The patterns of mean returns is analogous to the favorite-Iongshot bias in racing markets.

Keywords: Calendar Anomalies; Arbitrage; Stock Prices; Stock Returns; US Stock Market; Futures Markets; Betting; Trading Strategies; Sports Market; Lottery Market; Capital Growth Theory; Semi-Strong Market Efficiency; Speculative Investments; Index Futures; Factor Models Based on Fundamental Anomalies; Worldwide Stock Market Strategies (search for similar items in EconPapers)
Date: 2012
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