Researchers have reported mispricing in index options markets. This study further examines the efficiency of the S&P 500 index options market by testing theoretical pricing relationships implied by no-arbitrage conditions. The effect of a traded stock basket, Standard and Poor's Depository Receipts (SPDRs), on the link between index and options markets is also examined. Pricing efficiency within options markets improves, and the evidence supports the hypothesis that a stock basket enhances the connection between markets. However, when transactions costs and short sales constraints are included, very few violations of the pricing relationships are reported.
JEL classification: G13, G14
Key words: index options, pricing efficiency, traded stock baskets
The authors thank Brian Hatch, Shane Johnson, and Dan Waggoner for helpful comments. They also gratefully acknowledge financial support of the Social Sciences and Humanities Research Council of Canada. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Lucy F. Ackert, Research Department, Federal Reserve Bank of Atlanta, 104 Marietta Street, NW, Atlanta, Georgia 30303-2713, 404/498-8783, firstname.lastname@example.org, or Yisong S. Tian, Department of Finance, Schulich School of Business, York University, Toronto, Ontario M3J 1P3, 416/736-5073.
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