Co-movements of Index Options and Futures Quotes

Ruediger Fahlenbrach and Patrik Sandas
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Patrik Sandas: U of Virginia

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

Abstract: We re-examine the co-movements of index options and futures quotes first studied in Bakshi, Cao, and Chen (2000). We show that the frequency of quote co-movements that are inconsistent with standard option pricing models is significantly higher around option trades. We examine empirically two explanations for these co-movements. First, we show that in simulations the stochastic volatility model can generate approximately the right frequency of inconsistent co-movements when its parameters are chosen to match observed option prices. But even allowing for different regimes in trade and no-trade periods the model generates virtually the same frequency of inconsistent co-movements. Second, we examine the quote co-movements in event-time around trades and show that they are consistent with either traders picking off stale option quotes or with traders submitting aggressive limit orders. Our evidence suggest that inconsistent co-movements reflect both departures from the univariate diffusion model and market microstructure frictions.

Date: 2005-11
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Journal Article: Co-movements of index options and futures quotes (2009)
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