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Abstract

This thesis presents five empirical studies of equity and equity index options trading on the London International Financial Futures and Options Exchange (LEFFE). The common theme in this thesis is how an investor can circumvent the problems, or exploit the opportunities, presented by the institutional characteristics of the market. The analysis in all studies is model-independent.

The first study derives boundary conditions for the exercise of the wildcard option on American index options. Necessary conditions are denved for the wildcard to be of value and it transpires that these conditions are met only rarely, implying that the wildcard option is of little significance for these options. A test using the Fleming and Whaley [1994] model, which attributes a significant value to the wildcard option on S&P 100 index options, is consistent with the boundary condition tests in that it also attributes a small value to the wildcard option on LIFFE.

The second study analyses the frictions involved in early exercise These frictions create different exerase conditions for cash- and delivery-settled options. A set of testable hypotheses of rational exercise practice is denved and tested and the market is found to be largely efficient. Differences are observed between the actions of call option holders and those of put option holders. This is atttnbuted to a clientele effect, with a greater incidence of inexpenenced investors holding call options. A clientele effect is also inferred in the supply of options, with marketmakers taking a larger proportion of the short side of put options.

The third study compares the pncing of the Amencan and European index options traded on the FT-SE 100 index. Boundary conditions are denved and tested and a significant degree of rruspncing between the two styles of option is observed. However, the mispncing appears to be unsystematic and a limited test of an ex ante trading rule fails to show arbitrage profits Nevertheless, a modification to observed investor order placement strategy is proposed.

The fourth study considers another aspect of investor order placement strategy: the choice between limit orders and market orders. Limit orders require the investor to take on two types of information nsk, but can provide better trading prices than market orders. A strategy is developed and tested which proves effective in controlling the information risks, thus enabling an investor who uses limit orders to capture some of the bid-ask spread.

The final study examines the intraday pattern of the bid-ask spread on the Amencan index options, using a vanety of models. Partial conformity and partial violation is observed It is argued that the standard classification of investors as liquidity or informed traders is inappropriate in the case of index options and that this accounts for much of the observed violation.

In summary, the options market appears to be efficient, in the strict sense that no abnormal nsk- adjusted returns have been found. Nevertheless, the thesis finds a number of ways in which investors, given that they are going to trade on the market, can improve their investment performance.

Publication Type:	Thesis (Doctoral)
Subjects:	H Social Sciences > HG Finance
Departments:	Bayes Business School Bayes Business School > Bayes Business School Doctoral Theses Doctoral Theses

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