Futures price limit moves as options

✍ Scribed by Mark E. Holder; Christopher K. Ma; James E. Mallett

• Publisher: John Wiley and Sons
• Year: 2002
• Tongue: English
• Weight: 114 KB
• Volume: 22
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.10038

✦ Synopsis

Abstract

This note demonstrates that an asset's price in an environment with price limit rules can be replicated by
the price of a portfolio consisting of a riskless asset and two synthetic options. A procedure is developed to
unbundle the unobservable option values imbedded in the actual futures price and impute a theoretical true futures
price. Using this framework, evidence from the Treasury Bond futures market suggests that theoretical true futures
prices diverge from actual futures prices, on average, 3 h prior to the activation of price limit rules,
indicating that price limit moves might be predictable. The reversal of both the actual futures prices and the
theoretical futures prices back within the limit range after a limit move provides support for the possibility
that traders tend to overreact when market prices are near price limits. © 2002 Wiley Periodicals, Inc. Jrl
Fut Mark 22:901–913, 2002