TY - JOUR

T1 - The smirk in the S&P500 futures options prices

T2 - A linearized factor analysis

AU - Carverhill, Andrew

AU - Cheuk, Terry H.F.

AU - Dyrting, Sigurd

PY - 2009/7/1

Y1 - 2009/7/1

N2 - In the S&P500 futures options, we identify three factors, corresponding to movements in the underlying, parallel movements, and tilting of the cross section of implied volatilities (the "smirk factor"). We relate these factors non-linearly to movements in the option prices. They seem to be diffusive in nature, have significant associated risk premia, and can account for an overwhelming part of the option price movements. We interpret the options smirk, which is the notion that out-of-the-money (OTM) puts seem expensive relative to OTM calls, in terms of the prices of these risk factors. Going short OTM puts and long OTM calls, corresponding to the third factor, makes a profit on average, but this corresponds to its risk premium, and does not represent a market inefficiency. Our smirk factor is useful for hedging option portfolios, but seems unrelated to movements in the underlying, and does not fit into the framework of the jump-diffusion models.

AB - In the S&P500 futures options, we identify three factors, corresponding to movements in the underlying, parallel movements, and tilting of the cross section of implied volatilities (the "smirk factor"). We relate these factors non-linearly to movements in the option prices. They seem to be diffusive in nature, have significant associated risk premia, and can account for an overwhelming part of the option price movements. We interpret the options smirk, which is the notion that out-of-the-money (OTM) puts seem expensive relative to OTM calls, in terms of the prices of these risk factors. Going short OTM puts and long OTM calls, corresponding to the third factor, makes a profit on average, but this corresponds to its risk premium, and does not represent a market inefficiency. Our smirk factor is useful for hedging option portfolios, but seems unrelated to movements in the underlying, and does not fit into the framework of the jump-diffusion models.

KW - Futures

KW - Options

KW - S&P500 index

KW - Skew

KW - Smirk

UR - http://www.scopus.com/inward/record.url?scp=67649786643&partnerID=8YFLogxK

U2 - 10.1007/s11147-009-9037-2

DO - 10.1007/s11147-009-9037-2

M3 - Article

AN - SCOPUS:67649786643

VL - 12

SP - 109

EP - 139

JO - Review of Derivatives Research

JF - Review of Derivatives Research

SN - 1380-6645

IS - 2

ER -