Illiquidity Premia in the Equity Options Market

Review of Financial Studies

72 Pages Posted: 15 Mar 2011 Last revised: 22 Sep 2017

See all articles by Peter Christoffersen

Peter Christoffersen

University of Toronto - Rotman School of Management; Copenhagen Business School; Aarhus University - CREATES

Ruslan Goyenko

McGill University - Desautels Faculty of Management

Kris Jacobs

University of Houston - C.T. Bauer College of Business

Mehdi Karoui

OMERS

Date Written: September 21, 2017

Abstract

Standard option valuation models leave no room for option illiquidity premia. Yet we find the risk-adjusted return spread for illiquid over liquid equity options is 3.4 percent per day for at-the-money calls and 2.5 percent for at-the-money puts. These premia are computed using option illiquidity measures constructed from intraday effective spreads for a large panel of US equities, and they are robust to different empirical implementations. Our findings are consistent with evidence that market makers in the equity options market hold large and risky net long positions on average. We show that the positive illiquidity premium compensates market makers for the risks and costs of these long positions.

Keywords: Illiquidity; equity options; cross-section; delta-hedged option returns

JEL Classification: G12

Suggested Citation

Christoffersen, Peter and Goyenko, Ruslan and Jacobs, Kris and Karoui, Mehdi, Illiquidity Premia in the Equity Options Market (September 21, 2017). Review of Financial Studies, Available at SSRN: https://ssrn.com/abstract=1784868 or http://dx.doi.org/10.2139/ssrn.1784868

Peter Christoffersen

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5P 3C4
Canada
416-946-5511 (Phone)

Copenhagen Business School

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Aarhus University - CREATES

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Ruslan Goyenko (Contact Author)

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

Kris Jacobs

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

Mehdi Karoui

OMERS ( email )

200 Bay Street, Suite 2300
Toronto, Ontario M5J2J2
Canada

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