Option Happiness and Liquidity: Is the Dynamics of the Volatility Smirk Affected by Relative Option Liquidity?

53 Pages Posted: 11 Sep 2009

See all articles by Lars L. Norden

Lars L. Norden

Stockholm University - Stockholm Business School

Caihong Xu

Stockholm University - Stockholm Business School

Date Written: September 11, 2009

Abstract

This study investigates the dynamic relationship between option happiness (the steepness of the volatility smirk) and relative index option liquidity. We find that, on a daily basis, option happiness is significantly dependent on the relative liquidity between option series with different moneyness. In particular, the larger the difference in liquidity between an out-of-the-money option and a concurrent at-the-money call option, the larger the option happiness. This relationship is robust to various relative option liquidity measures based on bid-ask spreads, trading volumes and option price impacts. The results also show a significant maturity effect in option happiness, consistent with the notion that options are “dying smiling”.

Keywords: implied volatility, volatility smirk, option happiness, relative option liquidity

JEL Classification: G13

Suggested Citation

Nordén, Lars L. and Xu, Caihong, Option Happiness and Liquidity: Is the Dynamics of the Volatility Smirk Affected by Relative Option Liquidity? (September 11, 2009). Available at SSRN: https://ssrn.com/abstract=1472002 or http://dx.doi.org/10.2139/ssrn.1472002

Lars L. Nordén (Contact Author)

Stockholm University - Stockholm Business School ( email )

Sweden

Caihong Xu

Stockholm University - Stockholm Business School ( email )

Roslagsvägen 1010
Stockholm, SE-106 91
Sweden

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