Condor Options

Here are some recent articles of interest with their abstracts.  You’ll need university or institutional access for full text.

George M. Constantinides, Jens Carsten Jackwerth, and Stylianos Perrakis, “Mispricing of S&P 500 Index Options,” Rev. Financ. Stud. 2009 22: 1247-1277.

Widespread violations of stochastic dominance by 1-month S&P 500 index call options over 1986–2006 imply that a trader can improve expected utility by engaging in a zero-net-cost trade net of transaction costs and bid-ask spread. Although precrash option prices conform to the Black-Scholes-Merton model reasonably well, they are incorrectly priced if the distribution of the index return is estimated from time-series data. Substantial violations by postcrash OTM calls contradict the notion that the problem lies primarily with the left-hand tail of the index return distribution and that the smile is too steep. The decrease in violations over the postcrash period of 1988–1995 is followed by a substantial increase over 1997–2006, which may be due to the lower quality of the data but, in any case, does not provide evidence that the options market is becoming more rational over time.

Peter Carr and Liuren Wu, “Variance Risk Premiums,” Rev. Financ. Stud. 2009 22: 1311-1341.

We propose a direct and robust method for quantifying the variance risk premium on financial assets. We show that the risk-neutral expected value of return variance, also known as the variance swap rate, is well approximated by the value of a particular portfolio of options. We propose to use the difference between the realized variance and this synthetic variance swap rate to quantify the variance risk premium. Using a large options data set, we synthesize variance swap rates and investigate the historical behavior of variance risk premiums on five stock indexes and 35 individual stocks.

Kent Wang, “Volatility linkages of the equity, bond and money markets: an implied volatility approach,” Accounting & Finance 2009 49: 207-219.

This study proposes an alternative approach for examining volatility linkages between Standard & Poor’s 500, Eurodollar futures and 30 year Treasury Bond futures markets using implied volatility from the three markets. Simple correlation analysis between implied volatilities in the three markets is used to assess market correlations. Spurious correlation effects are considered and controlled for. I find that correlations between implied volatilities in the equity, money and bond markets are positive, strong and robust. Furthermore, I replicate the approach of Fleming, Kirby and Ostdiek (1998) to check the substitutability of the implied volatility approach and find that the results are nearly identical; I conclude that my approach is simple, robust and preferable in practice. I also argue that the results from this paper provide supportive evidence on the information content of implied volatilities in the equity, bond and money markets.