Order imbalance and the dynamics of index and futures prices

This study uses transaction records of index futures and index stocks, with bid/ask price quotes, to examine the impact of stock market order imbalance on the dynamic behavior of index futures and cash index prices. Spurious correlation in the index is purged by using an estimate of the “true” index with highly synchronous and active quotes of individual stocks. A smooth transition autoregressive error correction model is used to describe the nonlinear dynamics of the index and futures prices. Order imbalance in the cash stock market is found to affect significantly the error correction dynamics of index and futures prices. Order imbalance impedes error correction particularly when the market impact of order imbalance works against the error correction force of the cash index, explaining why real potential arbitrage opportunities may persist over time. Incorporating order imbalance in the framework significantly improves its explanatory power. The findings indicate that a stock market microstructure that allows a quick resolution of order imbalance promotes dynamic arbitrage efficiency between futures and underlying stocks. The results also suggest that the unloading of cash stocks by portfolio managers in a falling market situation aggravates the price decline and increases the real cost of hedging with futures. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:1129–1157, 2007     

A Study of Arbitrage Efficiency Between the FTSE‐100 Index Futures and Options Contracts

Despite the importance of the London markets and the significance of the relationship for market makers, little published research is available on arbitrage between the FTSE‐100 Index futures and the FTSE‐100 European index options contracts. This study uses the put–call–futures parity condition to throw light on the relationship between options and futures written against the FTSE Index. The arbitrage methodology adopted in this study avoids many of the problems that have affected prior research on the relationship between options or futures prices and the underlying index. The problems that arise from nonsynchroneity between options and futures prices are reduced by the matching of options and futures prices within narrow time intervals with time‐stamped transaction data. This study allows for realistic trading and market‐impact costs. The feasibility of strategies such as execute‐and‐hold and early unwinding is examined with both ex‐post and ex‐ante simulation tests that take into consideration possible execution time lags for the arbitrage trade. This study reveals that the occurrence of matched put–call–futures trios exhibits a U‐shaped intraday pattern with a concentration at both open and close, although the magnitude of observed mispricings has no discernible intraday pattern. Ex‐post arbitrage profits for traders facing transaction costs are concentrated in at‐the‐money options. As in other major markets, despite important microstructure differences, opportunities are generally rapidly extinguished in less than 3 min. The results suggest that arbitrage opportunities for traders facing transaction costs are small in number and confirm the efficiency of trading on the London International Financial Futures and Options Exchange. © 2002 John Wiley & Sons, Inc. Jrl Fut Mark 22:31–58, 2002     

Risk arbitrage opportunities in petroleum futures spreads

This article investigates the long-term pricing relationship among crude oil, unleaded gasoline, and heating oil futures prices, and finds that these commodities futures prices are cointegrated. The study finds that the spreads between crude oil and its end products are stationary. Furthermore, this article investigates the risk arbitrage opportunities in three types of popularly traded petroleum futures spreads and finds that historically profitable risk arbitrage opportunities existed and were statistically significant. However, one cannot be certain that these opportunities still exist. The research also finds that moving averages are valid test variables for measuring spreads. Statistical and tabular constructions are used to illustrate findings. © 1999 John Wiley & Sons, Inc., Jrl Fut Mark 19: 931–955, 1999     

Optimal No‐Arbitrage Bounds on S&P 500 Index Options and the Volatility Smile

This article shows that the volatility smile is not necessarily inconsistent with the Black–Scholes analysis. Specifically, when transaction costs are present, the absence of arbitrage opportunities does not dictate that there exists a unique price for an option. Rather, there exists a range of prices within which the option's price may fall and still be consistent with the Black–Scholes arbitrage pricing argument. This article uses a linear program (LP) cast in a binomial framework to determine the smallest possible range of prices for Standard & Poor's 500 Index options that are consistent with no arbitrage in the presence of transaction costs. The LP method employs dynamic trading in the underlying and risk‐free assets as well as fixed positions in other options that trade on the same underlying security. One‐way transaction‐cost levels on the index, inclusive of the bid–ask spread, would have to be below six basis points for deviations from Black–Scholes pricing to present an arbitrage opportunity. Monte Carlo simulations are employed to assess the hedging error induced with a 12‐period binomial model to approximate a continuous‐time geometric Brownian motion. Once the risk caused by the hedging error is accounted for, transaction costs have to be well below three basis points for the arbitrage opportunity to be profitable two times out of five. This analysis indicates that market prices that deviate from those given by a constant‐volatility option model, such as the Black–Scholes model, can be consistent with the absence of arbitrage in the presence of transaction costs. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:1151–1179, 2001     

Pricing dynamics of index options and index futures in Hong Kong before and during the Asian financial crisis

This article studies the impact of the Asian financial crisis on index options and index futures markets in Hong Kong. We employed a time‐stamped transaction data set of the Hang Seng Index options and futures contracts that were traded on the Hong Kong Futures Exchange. The results show that during the crisis period, the arbitrage profits, and the standard deviations of these profits increased in both ex‐post and ex‐ante analyses. In a market turbulent time, market volatility brings a higher arbitrage profit level. However, despite the increased market volatility, the profitability of the arbitrage trades declined substantially with longer execution time lags in the ex‐ante analysis. This suggests that the HSI futures and options markets are mature and resilient. A multiple regression analysis on the ex‐post arbitrage profit also suggests that there were structural changes during the Asian financial crisis and the Hong Kong government intervention periods. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20: 145–166, 2000     

Box‐spread arbitrage efficiency of Nifty index options: The Indian evidence

This study examines the market efficiency for the European style Nifty index options using the box‐spread strategy. Time‐stamped transactions data are used to identify the mispricing and arbitrage opportunities for options with this modelfree approach. Profit opportunities, after accounting for the transaction costs, are quite frequent, but do not persist even for two minutes. The mispricing is higher for the contracts with higher liquidity (immediacy) risk captured by the moneyness (the difference between the strike prices and the spot price) and the volatility of the underlying. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:544–562, 2009     

An intraday test of pricing and arbitrage opportunities in the New Zealand bank bill futures market

This paper examines pricing and arbitrage opportunities in the New Zealand bank bill futures market using an intraday data set. The key findings are: (a) the implied forward rate model yields biased estimates of the bill futures yield but the bias is small and not economically significant; (b) ex post synthetic bill opportunities are more numerous than ex post quasi‐arbitrage opportunities but the yield enhancements are minor; (c) ex post quasi‐arbitrage opportunities are substantially less frequent and less profitable than reported by prior studies using closing data; and (d) arbitrage opportunities decline when execution delays are introduced but the declines are not statistically significant. In broad terms, the bill futures market is efficient with respect to quasi‐arbitrage but less so with respect to synthetic bill opportunities. The results also suggest that arbitrage opportunities are not generally available to arbitrageurs without access to the interbank bill market. The incidence of arbitrage opportunities is on a par with levels reported in intraday studies of stock index and foreign exchange markets. This illustrates the importance of using high frequency data to assess transactional efficiency in financial markets. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:519–555, 2002     

Cross-market efficiency in the Indian derivatives market: A test of put–call parity

This study examines the cross-market efficiency of the Indian options and futures market using model-free tests. The put–call–futures and put–call–index parity conditions are tested for European style Nifty Index options. Thirty-five-month time-stamped transactions data are used to identify mispricing. Frequent violations of both forms of put–call parity are observed. The restriction on short sales largely accounts for the put–call–index parity violations. There are numerous put–call–futures arbitrage profit opportunities even after accounting for transaction costs, which vanish quickly. Put options are overpriced more often than call options. The mispricing shows specific patterns with respect to time of the day, moneyness, volatility, and days to expiry. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:889–910, 2008     

The limits to stock index arbitrage: Examining S&P 500 futures and SPDRS

This study examines factors affecting stock index spot versus futures pricing and arbitrage opportunities by using the S&P 500 cash index and the S&P 500 Standard and Poor's Depository Receipt (SPDR) Exchange‐Traded Fund (ETF) as “underlying cash assets.” Potential limits to arbitrage when using the cash index are the staleness of the underlying cash index, trading costs, liquidity (volume) issues of the underlying assets, the existence of sufficient time to execute profitable arbitrage transactions, short sale restrictions, and the extent to which volatility affects mispricing. Alternatively, using the SPDR ETF as the underlying asset mitigates staleness and trading cost problems as well as the effects of volatility associated with the staleness of the cash index. Minute‐by‐minute prices are compared over different volatility levels to determine how these factors affect the limits of S&P 500 futures arbitrage. Employing the SPDR as the cash asset examines whether a liquid tradable single asset with low trading costs can be used for pricing and arbitrage purposes. The analysis examines how long mispricing lasts, the impact of volatility on mispricing, and whether sufficient volume exists to implement arbitrage. The minute‐by‐minute liquidity of the futures market is examined using a new transaction volume futures database. The results show that mispricings exist regardless of the choice of the underlying cash asset, with more negative mispricings for the SPDR relative to the S&P 500 cash index. Furthermore, mispricings are more frequent in high‐ and mid‐volatility months than in low‐volatility months and are associated with higher volume during high‐volatility months. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:1182–1205, 2008     

Arbitrage,cointegration, and the joint dynamics of prices across discrete commodity futures auctions

Underlying the search for arbitrage opportunities across commodity futures markets that differ in market structure is the idea that the futures prices for similar commodities that are traded on different exchanges adjusted for differences in currency, delivery time (if any), location, and market structure are equal. This article examines price linkages in competing discrete commodity futures auction markets. We find no evidence of cointegration of futures prices of similar commodities traded on two contemporaneous discrete auction futures exchanges in Asia. We also find no evidence of arbitrage activities across these two Asian exchanges, though this does not preclude arbitrage activities with North American continuous auction markets. This lack of cointegration may be due to nonstationarities in the trading cost component. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 799–815, 1999     

Short selling,unwinding, and mispricing

This article highlights the impact of short selling restrictions and early unwinding opportunities on the relation between futures and spot prices. Within a multiperiod equilibrium model, the influence of optimal arbitrage trading on the mispricing is analyzed. Results concerning trade volume and level, mean reversion, and path dependence of the mispricing are provided. The empirical evidence suggests that short selling restrictions and early unwinding opportunities are influential factors for the mispricing behavior. They help explain empirical findings reported in the literature. © 1998 John Wiley & Sons, Inc. Jrl Fut Mark 18:903–923, 1998     

Optimal arbitrage strategies on stock index futures under position limits

Assuming the absence of market frictions, deterministic interest rates, and certainty in dividend payouts from the stocks in the index basket, an arbitrageur can lock in the profit of a positive (negative) arbitrage basis in a stock index futures by adopting a short (long) futures strategy. In addition, the arbitrageur may improve the arbitrage profit by adopting the so‐called early unwinding strategy of liquidating the position before maturity, or more aggressively from the long position directly to the short position or vice versa. In this study, we examine the optimal arbitrage strategies in stock index futures with position limits and transaction costs. In our analysis, the index arbitrage basis is assumed to follow the Brownian Bridge process. The model formulation of the option value functions leads to a coupled system of variational inequalities. We determine the values of the arbitrage opportunities and the optimal threshold values of the arbitrage basis at which the arbitrageur should optimally close an existing position or open a new index arbitrage position. In particular, we examine the impact of transaction costs on the index arbitrage strategies. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:394–406, 2011     

Lower‐boundary violations and market efficiency: Evidence from the German DAX‐index options market

The informational efficiency of the market for options on the German stock index DAX is examined using intraday transactions data. Problems of previous studies on options‐market efficiency, arising from dividend estimation and the early‐exercise effect, are avoided, because the DAX is a performance index and DAX options are European options. Ex‐post and ex‐ante tests are carried out to simulate trading strategies that exploit irrational lower‐boundary violations of observed option prices. Because the lower‐boundary conditions are solely based on arbitrage considerations, the test results do not depend on the assumption that investors use a particular option‐pricing model. The investigation shows that ex‐post profits are, in general, dramatically reduced when the execution of arbitrage strategies is delayed and/or transaction costs are accounted for. However, arbitrage restrictions, which rely on short selling of the component stocks of the index, tend to be violated more often and with higher persistence. An analysis of consecutive subsamples suggests that, over time, traders have been subjected to a learning process when pricing this relatively new instrument. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20: 405–424, 2000     

Changes in the options contract size and arbitrage opportunities

We examine the impacts of changes to the options multiplier on market efficiency by analyzing their effects on arbitrage proxies based on the performance of options spread strategies. Despite the intentions of the reforms, both decisions to raise and reduce the multiplier significantly increase the frequency and probability of arbitrage opportunities. Whereas the increment in the multiplier also deteriorates market efficiency by increasing the duration and average size of the arbitrage opportunities in a day, the decrement does not affect these proxies. Our results overall provide evidence that reforms to the options multiplier do not enhance market efficiency and suggest that retail investors are not homogeneously noisy.     

Order imbalance and the pricing of index futures

This study examines whether the aggregate order imbalance for index stocks can explain the arbitrage spread between index futures and the underlying cash index. The study covers the period of the Asian financial crisis and includes wide variations in order imbalance and the indexfutures basis. The analysis controls for realistic trading costs and actual dividend payments. The results indicate that the arbitrage spread is positively related to the aggregate order imbalance in the underlying index stocks; negative order‐imbalance has a stronger impact than positive order imbalance. Violations of the upper no‐arbitrage bound are related to positive order imbalance; of the lower no‐arbitrage bound to negative order imbalance. Asymmetric response times to negative and positive spreads can be attributed to the difficulty, cost, and risk of short stock arbitrage when the futures are below their no‐arbitrage value. The significant relationship between order imbalance and arbitrage spread confirms that index arbitrageurs are important providers of liquidity in the futures market when the stock market is in disequilibrium. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:697–717, 2007     

Market microstructure of FT-SE 100 index futures: An intraday empirical analysis

This article examines the market microstructure of the FT-SE Index futures market by analyzing the intraday patterns of bid-ask spreads and trading activity. The patterns are remarkably different from those of stock and options markets because of the futures market's open outcry system with frenzied scalpers/short-term marketmakers. Spreads are stable over the day, but decline sharply at the close and increase when U.S. macroeconomic news is distributed. Traders actively trade at the open with narrow spreads and large trade sizes. Volatility and volume have higher values at the open and close and when U.S. news is released. The overall results suggest that information asymmetry in the index futures market is insignificant, and traders find it easy to control inventory. The results are also broadly consistent with the Grossman and Miller (1988) model that describes liquidity as the price of transaction demand for immediacy. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 31–58, 1999     

沪深300股指期货定价实证研究

股指期货是一种发展迅速的金融衍生产品,而合约定价问题是其重要研究方向之一。股指期货定价的基本方法是利用无套利定价原理得出的持有成本模型;而如果综合交易费用、融资成本、存贷款利差、保证金等市场因素,则可以得到股指期货的无套利定价区间。使用这两种模型对中国金融期货交易所的沪深300股指期货仿真交易合约进行实证分析,结果发现,实际交易价格和理论价格有较大偏差,市场中存在大量套利机会,定价效率有待提高。为此可以考虑的建议包括允许融资融券交易、推出沪深300指数ETF等。     

Directly measuring early exercise premiums using American and European S&P 500 Index options

The Chicago Board Options Exchange concurrently listed European‐style and American‐style options on the Standard and Poor's 500 Index from April 2, 1986 through June 20, 1986. This unique time period allows for a direct measurement of the early exercise premium in American‐style index options. In this study, using ask quotes, we find average early exercise premiums ranging from 5.04 to 5.90% for calls, and from 7.97 to 10.86% for puts. Additionally, we are able to depict a potentially useful functional form of the early exercise premium. As in previous studies, we find some instances of negative early exercise premiums. However, a trading simulation shows that traders must be able to trade within the bid–ask spread to profit from these apparent arbitrage opportunities. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:287–313, 2003     

Optimal dynamic behavior of a market maker in choosing bid and asked prices

Dynamic programming is used to describe a specialist's choice of bid and asked prices given uncertainty about both limit and market orders. The role of limit orders is emphasized. Optimal quotes depend on the composition of limit orders, the size of the specialist's position, and the time of day. The optimal bid-ask spread, however, depends only on the composition of the book. The capitalized value of the specialist's franchise is studied. Long-run probability distributions for bid and ask prices are obtained, which show that the variances of these prices increase as the end of the day approaches.     

Pricing efficiency of the S&P 500 index market: Evidence from the Standard & Poor's Depositary Receipts

Standard & Poor's Depositary Receipts (SPDRs) are exchange traded securities representing a portfolio of S&P 500 stocks. They allow investors to track the spot portfolio and better engage in index arbitrage. We tested the impact of the introduction of SPDRs on the efficiency of the S&P 500 index market. Ex‐post pricing efficiency and ex‐ante arbitrage profit between SPDRs and futures were also examined. We found an improved efficiency in the S&P 500 index market after the start of SPDRs trading. Specifically, the frequency and length of lower boundary violations have declined since SPDRs began trading. This result is consistent with the hypothesis that SPDRs facilitate short arbitrage by simplifying the process of shorting the cash index against futures. Tests of pricing efficiency comparing SPDRs and futures suggested that index arbitrage using SPDRs as a substitute for program trading in general results in losses. Although short arbitrages earn a small profit on average, gains are statistically insignificant. A trade‐by‐trade investigation showed that prices are instantaneously corrected after the presence of mispricing signals, introducing substantial risk in arbitraging. Evidence in general supported pricing efficiency between SPDRs and the S&P 500 index futures—both ex‐post and ex‐ante. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:877–900, 2002