Price-to-Earnings Ratios and Option Prices
Journal of Futures Markets, Forthcoming
28 Pages Posted: 9 Feb 2015
Date Written: October 24, 2014
In May of 1997, in the midst of the internet bubble, the average month end P/E ratio for the software industry was 44. However, the five year historical average was 31. In this study we examine the effect of this industry value fluctuation on the effects of option prices. We examine the relationship between the level of relative valuation and option pricing via deviations in put-call parity and a two factor option pricing model incorporating relative valuation. We find support that the increase in relative industry valuation Granger causes put-call parity deviations, implying investors price options with greater expectation of downward movement. Additionally, we develop a model and find support that the two factor option pricing model which incorporates relative industry valuation prices options better than the standard Black-Scholes (1973) model.
Keywords: Option pricing model, price-to-earnings ratios, market efficiency
JEL Classification: G10, G12, G13, G14
Suggested Citation: Suggested Citation