Option Happiness and Liquidity: Is the Dynamics of the Volatility Smirk Affected by Relative Option Liquidity?
53 Pages Posted: 11 Sep 2009
Date Written: September 11, 2009
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
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