This paper investigates the efficiency of the market for foreign currency options with the help of a modified version of the Black-Scholes model. The evidence in the ex post tests is inconsistent with this hypothesis since we find a large number of opportunities for abnormal profits. A second set of tests is conducted on an ex ante basis to determine whether these profit opportunities exist even if the execution of the strategy is delayed by one day. The evidence from these tests provides more support for the hypothesis of market efficiency.

Pricing models for American call and put options on futures contracts are derived herein. These models are used to investigate the efficiency of the market for options on Standard & Poor 500 and German Mark futures. The evidence presented here indicates that market prices for these options deviate substantially from their corresponding model prices. In addition, it is shown that a hedging strategy originated at prices that indicate a deviation of market from model is successful in translating the observed mispricing into excess profits after transactions costs. However, these net profits are eliminated if the origination of the strategy is delayed by one trade, or if bid-ask spreads are accounted for.

Robert Geske, Kuldeep Shastri, Valuation by Approximation: A Comparison of Alternative Option Valuation Techniques, The Journal of Financial and Quantitative Analysis, Vol. 20, No. 1 (Mar., 1985), pp. 45-71

We find that option listings are associated with a decrease in the variance of the pricing error, a decrease in the adverse selection component of the spread, and an increase in the relative weight placed by the specialist on public information in revising prices for the underlying stocks. We also find that there is a decrease in the spread and increases in quoted depth, trading volume, trading frequency, and transaction size after option listings. Overall, our results suggest that option listings improve the market quality of the underlying stocks.

We examine the impact of changes in equity-option margin requirements on the liquidity of options and underlying stock markets. We find that the decrease in margin was associated with an increase in spreads and trade informativeness, and a decrease in depth for the underlying stocks. In contrast, options spreads decreased indicating a change in the relative allocation of informed traders between the two markets. When the required margin was increased, no significant change was observed in the underlying stocks, but option spreads increased. Overall, our results indicate that uninformed traders are more sensitive to the margin dimension of trading costs.

ABSTRACT We examine the impact of changes in equity‐option margin requirements on the liquidity of options and underlying stock markets. We find that the decrease in margin was associated with an increase in spreads and trade informativeness, and a decrease in depth for the underlying stocks. In contrast, option spreads decreased indicating a change in the relative allocation of informed traders between the two markets. When the required margin was increased, no significant change was observed in the underlying stocks, but option spreads increased. Overall, our results indicate that uninformed traders are more sensitive to the margin dimension of trading costs.

The authors examine the impact of changes in equity-option margin requirements on the liquidity of options and underlying stock markets. They find that the decrease in margin was associated with an increase in spreads and trade informativeness, and a decrease in depth for the underlying stocks. In contrast, option spreads decreased indicating a change in the relative allocation of informed traders between the two markets. When the required margin was increased, no significant change was observed in the underlying stocks but option spreads increased. Overall, the authors' results indicate that uninformed traders are more sensitive to the margin dimension of trading costs.

This paper investigates the behavior of stock and option prices around block trades in stocks. The results indicate that for both uptick and downtick block trades the stock prices adjust within a fifteen minute period after the block trade. Moreover, for uptick blocks there is no evidence of any stock price reaction before the block trade. However, the adjustment of stock price for downtick blocks begins about fifteen minutes before the block trade. They also find that option price behavior differs considerably from stock price behavior. Specifically, the authors' results suggest that options exhibit abnormal price behavior starting thirty minutes before the block and ending one hour after the block. The pattern is more pronounced for downtick blocks and for put options. The authors interpret this abnormal price behavior of options before the block trade as consistent with intermarket frontrunning.