Market Frictions and Seemingly Anomalous Co-movements of Index Options and Index Futures Quotes

Ruediger Fahlenbrach and Patrik Sandas ()

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: A call option price is always an increasing and convex function of the underlying asset price whenever the underlying asset price follows a diffusion whose volatility depends only on time and the concurrent asset price-a one-dimensional diffusion. We empirically examine how often the observed quote movements are anomalous in the sense that they imply a violation of either the monotonicity or the convexity property using a sample of quotes and trades of options and futures on the FTSE 100 stock index. We show that such anomalous co-movements are about four times more likely to occur within a minute of an option trade than at other times and are related to the traders' order submissions. We interpret our results as evidence that the seemingly anomalous quote co-movements are driven by market frictions and should not be taken as evidence against option pricing models in the one-dimensional diffusion family. We show that the seemingly anomalous quote co-movements are consistent with traders making rational order submission decisions.

JEL-codes: C33 (search for similar items in EconPapers)
Date: 2005-01
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