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

Impacts of Introducing Short Maturity Options

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French National Center of Scientific Research European Financial Data Institute Stephan Dieckmann

Wharton Business School, University of Pennsylvania

Patrice Fontaine

CNRS (EUROFIDAI) & University of Grenoble (CERAG)

Youssef Khoali

CNRS (EUROFIDAI)

The sixth Vietnam Economist Annual Meeting (VEAM 2013)

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

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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

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Impacts of Introducing Short Maturity Options Agenda

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

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

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I. Why introducing these options? ‘The Expiration Day Effects’

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options 5

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
• I. Why introducing these options?

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

Financial Innovation: issue shorter-term

• ptions

The trading activity is very high at the end

• f the option’s

life Exchanges are profit- maximizing economic agents

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• I. Why introducing these options?

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

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

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• II. Overview of Short Maturity Options Markets

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

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)

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• II. Overview of Short Maturity Options Markets

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

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)

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• III. Research Questions

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options 10

Question 2: Did the introduction of daily and weekly

• ptions 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.

• III. Research Questions

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options 11

IV-1. Data IV-2. Impact on existing options volumes (and global) IV-3. Impact on the volatility of the underlying market

• IV. Empirical Analysis

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

• 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.

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VI-1. Data

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options 13 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)

VI-2. Impact on existing options volumes

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options 14

Contracts Weekly 10% Daily 20% Premium Turnover Weekly 5% Daily 5%

Daily and weekly options represent 30% of the traded volumes and only 10% of the traded value.

VI-2. Impact on existing options volumes

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

The methodology:

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)

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VI-2. Impact on existing options volumes

Control variables Impact of introducing short maturity options

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Impacts of introducing: (1) weekly options on existing monthly

• ptions

(2) weekly options on all AEX

• ptions (weekly plus

monthly) (3) daily options on monthly

• ptions

(4) daily options on weekly

• ptions

(5) daily options on all AEX

• ptions (daily plus weekly

plus monthly)

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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

• ptions

(4) daily options on weekly

• ptions

(5) daily options on all AEX

• ptions (daily plus weekly

plus monthly)

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Impacts of introducing: (1) weekly options on existing monthly options (2) weekly options on all AEX

• ptions (weekly plus

monthly) (3) daily options on monthly options (4) daily options on weekly

• ptions

(5) daily options on all AEX

• ptions (daily plus weekly

plus monthly)

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Impacts of introducing: (1) weekly options on existing monthly options (2) weekly options on all AEX

• ptions (weekly plus

monthly) (3) daily options on monthly

• ptions

(4) daily options on weekly

• ptions

(5) daily options on all AEX

• ptions (daily plus weekly

plus monthly)

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Impacts of introducing: (1) weekly options on existing monthly options (2) weekly options on all AEX

• ptions (weekly plus

monthly) (3) daily options on monthly

• ptions

(4) daily options on weekly

• ptions

(5) daily options on all AEX

• ptions (daily plus

weekly plus monthly)

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

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.

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VI-2. Impact on existing options volumes

Monthly Options Monthly Options Weekly Options Volume transfer

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

Results: Daily options:

The introduction of daily options has a negative impact on the volumes

• f existing weekly and monthly options.

The impact is also negative on global option volumes

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VI-2. Impact on existing options volumes

Weekly plus Monthly Options Weekly plus Monthly Options Daily Options Volume transfer

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

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

• ptions trading activity.

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VI-2. Impact on existing options volumes

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

Methodology: We use a GARCH(1,1) model to modelize the change of underlying market’s volatility:

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We introduce two dummy variables:

• Introduction of weekly options:
• Introduction of daily options:

VI-3. Impact on the stability of the underlying market

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

The studied period: 2004 - 2010

V2X (Europe) VAEX (Amsterdam)

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A solution is to detrend the AEX Index returns using another benchmark index and to study the residuals. VI-3. Impact on the stability of the underlying market

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options 26

AEX Index returns CAC 40 Index returns Residuals

GARCH mean model: Detrended:

VI-3. Impact on the stability of the underlying market

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options 27

We observe an increase of volatility after daily and weekly

• ptions introductions.

VI-3. Impact on the stability of the underlying market

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

Results: We observe an increase of volatility after daily and weekly options introductions. Follow-up questions: Can the increase of the volatility be explained by the level of information and sophistication of the traders of daily and weekly options ? Who trades daily, weekly and monthly options? Who sells and who buys the options? Does the traders’ structure change after the options introduction?

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VI-3. Impact on the stability of the underlying market

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

Three Different Trader Categories:

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VI-3. Impact on the stability of the underlying market

Brokers (market members

• r dealers)

Market makers Clients

On Euronext markets,

• nly brokers

(members) are entitled to place orders on the trading platform. When a member acts as a market maker, it means that he “commits” to Euronext as part of a contract to participate in improving market liquidity. Clients, individuals or corporations without direct market access, must pass through a member to perform their transactions. They consist of all other investors than brokers (members) or market makers.

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

Few studies could examine which category of traders exchanges the options: Lakonishok et al. (2007), Mahani et Poteshman (2008), Pan et Poteshman (2006), Poteshman et Serbin (2003), Barber et al. (2009), Chang et al., (2008) The results show that the clients of brokers are the least informed and the least sophisticated agents.

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VI-3. Impact on the stability of the underlying market

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

Who trades daily, weekly and monthly options? Who sells and who buys each option?

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VI-3. Impact on the stability of the underlying market

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

The monthly options traders evolution:

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The weekly options traders evolution:

VI-3. Impact on the stability of the underlying market

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

Results:

• The daily and weekly options are mainly traded by the clients, which

are the least informed and the least sophisticated traders.

• Brokers and market makers sell daily options and clients buy them.
• The proportion of members is unchanged, the clients’ proportions

increased for options with short maturity and decreased for longer maturity, this change was offset by brokers (market members).

• One explanation of the increase of the underlying market’s volatility

may be the information and sophistication level of the traders who exchange the daily and weekly options.

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VI-3. Impact on the stability of the underlying market

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

Introducing daily and weekly options has a negative impact on the volume of existing options. There is a transfer of the trading activity from long to short maturity options. Moreover, the global volume decreases after the introduction because of the high leverage effect of these options. Therefore, the daily and weekly options introduction seems to reduce the income of NYSE Euronext linked to the AEX options trading. The trading activity on daily and weekly options causes an increase of the volatility of the underlying market because of the clients who trade them.

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• V. Conclusion

CNRS - EUROFIDAI Impacts of Introducing Short Maturity Options

Future research

Study other impacts that the introduction of short maturity options may have. Explore the impact of the introduction of short maturity

• ptions on the volumes of the underlying market.

Perform cross sectional studies including the other markets that introduced short maturity options.

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• V. Conclusion

Impacts of Introducing Short Maturity Options

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French National Center of Scientific Research European Financial Data Institute Stephan Dieckmann

Wharton Business School, University of Pennsylvania

Patrice Fontaine

CNRS (EUROFIDAI) & University of Grenoble (CERAG)

Youssef Khoali

CNRS (EUROFIDAI)

The sixth Vietnam Economist Annual Meeting (VEAM 2013)