Impacts of Introducing Short Maturity Options Stephan Dieckmann - PowerPoint PPT Presentation

French National Center of Scientific Research European Financial Data Institute The sixth Vietnam Economist Annual Meeting (VEAM 2013) Impacts of Introducing Short Maturity Options Stephan Dieckmann Wharton Business School, University of Pennsylvania Patrice Fontaine CNRS (EUROFIDAI) & University of Grenoble (CERAG) Youssef Khoali CNRS (EUROFIDAI) 1

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options Introduction � Options are contracts between two parties, under which one party gives the other party � the right (but not the obligation) to buy (a call option) or to sell (a put option) an underlying asset � at a predetermined price (strike) � in a future date (European style) (maturity) or until a date (American style) � Options (derivatives) are used: � For hedging underlying asset positions � For arbitrage � As alternative investment instruments with a higher leverage 2

Impacts of Introducing Short Maturity Options Agenda I. Why introducing these options? II. Overview of Short Maturity Options Markets III. Research Questions IV. Empirical Analysis IV.1 Data IV.2 Impact on existing options volumes (and global) IV.3 Impact on the volatility of the underlying market V. Conclusion 3

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options I. Why introducing these options? ‘The Expiration Day Effects’ First US papers to address those effects are Stoll and Whaley (1986), Stephan and Whaley (1990), Stoll and Whaley (1991), Stoll and Whaley (1997), Stoll and Whaley (1990a). Other studies followed in other markets such as Corredor et al. (2001), Chamberlain et al. (1989), Chow et al. (2003) or Bollen and Whaley (1999) . Studies conclude: • High trading activity at the end of the life of options • Abnormal volatilities • Abnormal returns 4

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options I. Why introducing these options? Volumes of AEX Options presented by number of days to expirations (6 months): • The highest volumes (number of contracts) are observed at the expiration of the options • Same results using premium turnover and open interest 5

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options I. Why introducing these options? The trading Exchanges activity is very are profit- high at the end maximizing of the option’s economic life agents Financial Innovation: issue shorter-term options 6

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options II. Overview of Short Maturity Options Markets The short maturity options business is currently experiencing a very strong growth in global financial markets. • CBOE introduced weekly options in 2005, developed in 2010 and plans to launch daily options (SEC) • NYSE Euronext introduced weekly options in 2006 and daily in 2008. • Eurex 2006 (weekly) • CME 2011 (weekly) • ICE 2012 (weekly) • NYSE Euronext launch mini options (weekly options) on NYSE Arca and NYSE Amex on March 18, 2013. • WE FOCUS ON NYSE EURONEXT AMSTERDAM 7

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options II. Overview of Short Maturity Options Markets � Short Maturity Options Specificities � The premium of weekly and daily options is lower than the premium of standard monthly options. � High leverage (gamma). � Repeat the expiration day effect more frequently (trading strategies) 8

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options III. Research Questions Question 1: What is the impact of introducing daily and weekly options on the volumes of the existing standard options? We analyze the impact of the introduction of weekly options on the volumes of : • monthly options • all AEX options (weekly plus monthly) daily options on the volumes of: • monthly options • weekly options • all AEX options (daily plus weekly plus monthly) 9

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options III. Research Questions Question 2: Did the introduction of daily and weekly options stabilize or destabilize the underlying market? � Volatility increase: Conrad (1989), Vipul et al. (1989), Damodaran et Lim (1991), Damodaran et Subrahmanyam (1992), Fedenia et al. (1992), Kumar et al. (1995), Kumar et al. (1998) , Cox (1976) et Watt et al. (1992), Nabar et Park (1994) � Volatility decrease: Skinner (1989), Stein (1987), Hodgson et Nicholls (1991), Harris (1989), Lee et Ohk, (1992), Kamara et al. (1992), Antoniou et Holmes (1995), Chang et al. (1999). The increase or decrease in the volatility level depends on a fundamental assumption about the level of information of the traders on the derivative market. 10

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options IV. Empirical Analysis IV-1. Data IV-2. Impact on existing options volumes (and global) IV-3. Impact on the volatility of the underlying market 11

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options VI-1. Data • We focus our research on NYSE Euronext because it is the market where the short maturity options are the most developed and the only one to introduce daily options. • We use a data set provided by NYSE Euronext . The period starts in 2004 and ends in 2008 for options data and in 2010 for index data. We split it into three sub-periods delimited by options introductions. • Data include variables related to the volumes , the prices and the trader categories that submitted the orders. 12

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options VI-2. Impact on existing options volumes Value of AEX Index Options volumes in number of contracts (first graph) and premium turnover (second graph) 2005-2010 (monthly option on the left axis, daily and weekly options on the right axis) 13

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options VI-2. Impact on existing options volumes Premium Turnover Contracts Weekly 5% Weekly 10% Daily 5% Daily 20% Daily and weekly options represent 30% of the traded volumes and only 10% of the traded value. 14

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options VI-2. Impact on existing options volumes The methodology: Control variables Impact of introducing short maturity options � Endogenous Variable : -Volume of the options (O) � Explanatory Variables: - Trend of the derivative market (M) - CAC40 Index Options - Activity of the Underlying Market (S) - Volumes of Underlying Stocks - Volatility of the Underlying Market (V) - Realized volatility - Expiration day effect (EM and EW) - Number of days to expiration for weekly and monthly options - Introduction of daily options (DW and DD) - Dummy variable (0 before, 1 after the introduction of each option) 15

Impacts of introducing: (1) weekly options on existing monthly options (2) weekly options on all AEX options (weekly plus monthly) (3) daily options on monthly options (4) daily options on weekly options (5) daily options on all AEX options (daily plus weekly plus monthly) 16

Impacts of introducing: (1) weekly options on existing monthly options (2) weekly options on all AEX options (weekly plus monthly) (3) daily options on monthly options (4) daily options on weekly options (5) daily options on all AEX options (daily plus weekly plus monthly) 17

Impacts of introducing: (1) weekly options on existing monthly options (2) weekly options on all AEX options (weekly plus monthly) (3) daily options on monthly options (4) daily options on weekly options (5) daily options on all AEX options (daily plus weekly plus monthly) 18

Impacts of introducing: (1) weekly options on existing monthly options (2) weekly options on all AEX options (weekly plus monthly) (3) daily options on monthly options (4) daily options on weekly options (5) daily options on all AEX options (daily plus weekly plus monthly) 19

Impacts of introducing: (1) weekly options on existing monthly options (2) weekly options on all AEX options (weekly plus monthly) (3) daily options on monthly options (4) daily options on weekly options (5) daily options on all AEX options (daily plus weekly plus monthly) 20

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options VI-2. Impact on existing options volumes Results: Weekly options: � There is a negative impact of introducing weekly options on the volumes of existing monthly options. � The impact of the weekly options introduction on global option volumes is negative as well. Weekly Volume transfer Options Monthly Options Monthly Options 21

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options VI-2. Impact on existing options volumes Results: Daily options: � The introduction of daily options has a negative impact on the volumes of existing weekly and monthly options. � The impact is also negative on global option volumes Daily Volume transfer Options Weekly plus Monthly Options Weekly plus Monthly Options 22

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options VI-2. Impact on existing options volumes Results: In general, short maturity options are cannibalizing long maturity options. Introducing these options does not seem interesting for NYSE Euronext considering their incomes related to the AEX options trading activity. 23