Option happiness and liquidity: Is the dynamics of the volatility smirk affected by relative option liquidity?
✍ Scribed by Lars Nordén; Caihong Xu
- Publisher
- John Wiley and Sons
- Year
- 2011
- Tongue
- English
- Weight
- 227 KB
- Volume
- 32
- Category
- Article
- ISSN
- 0270-7314
No coin nor oath required. For personal study only.
✦ Synopsis
This study investigates the dynamic relationship between option happiness (the steepness of the volatility smirk) and relative index option liquidity. We find that, on a daily basis, option happiness is significantly dependent on the relative liquidity between option series with different moneyness. In particular, deterioration (improvement) in liquidity of an out-of-the-money put option relative to a concurrent at-the-money call option would lead to higher (lower) option happiness. This relationship is robust to relative option liquidity measures based on bid-ask spreads, option price impacts, and option order book imbalances. The results also show a significant maturity effect in option happiness, consistent with the notion that options are "dying smiling.