Option Trading Costs Are Lower than You Think
87 Pages Posted: 20 Mar 2015 Last revised: 7 Oct 2019
Date Written: October 4, 2019
Conventional estimates of costs of taking liquidity in options markets are large. Nonetheless, options trading volume is high. We resolve this puzzle by showing that options price changes are predictable at high frequency and many traders time executions by buying (selling) when the option fair value is close to the ask (bid). Effective spreads of traders who time executions are less than 40% of the size of conventional measures, and the overall average effective spread is one-quarter smaller than conventional estimates. Price impact measures are also affected. These findings alter conclusions about the after-cost profitability of options trading strategies.
Keywords: Execution timing, trading costs, effective spread, liquidity, equity options, algorithmic trading
JEL Classification: G14, G13
Suggested Citation: Suggested Citation