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Trading volatility spreads: a test of index option market efficiency

Poon, Ser-Huang and Pope, Peter (2000) Trading volatility spreads: a test of index option market efficiency. European Financial Management, 6 (2). pp. 235-260. ISSN 1354-7798

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Identification Number: 10.1111/1468-036X.00122

Abstract

If returns on two assets share common volatility components, the prices of options on the assets should be interdependent and the implied volatility spread should mean revert. We first demonstrate, using the canonical correlation method, that there is a common component in the volatilities of the returns on S&P 100 and S&P 500 indices. We then exploit this commonality by trading on the volatility spread between tick-by-tick OEX and SPX call options listed on the CBOE. Our vega-delta-neutral strategies generated significant profits, even after transaction costs are taken into account. The results suggest that the two options markets are not jointly efficient.

Item Type: Article
Official URL: http://onlinelibrary.wiley.com/journal/10.1111/(IS...
Additional Information: © 2000 Blackwell Publishers
Divisions: Accounting
Subjects: H Social Sciences > HG Finance
JEL classification: G - Financial Economics > G0 - General
Sets: Departments > Accounting
Date Deposited: 30 Oct 2013 14:47
Last Modified: 20 Feb 2019 07:29
URI: http://eprints.lse.ac.uk/id/eprint/53926

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