The Supply and Demand of S&P 500 Put Options

56 Pages Posted: 11 May 2015 Last revised: 18 May 2015

See all articles by George M. Constantinides

George M. Constantinides

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Lei Lian

University of Massachusetts Amherst - Isenberg School of Management

Date Written: May 2015

Abstract

We document that the implied volatility skew of S&P 500 index puts is non-decreasing in the disaster index and risk-neutral variance, contrary to the implications of a broad class of no-arbitrage models. The key to the puzzle lies in recognizing that, as the disaster risk increases, customers demand more puts as insurance while market makers become more credit-constrained in writing puts. The resulting increase in the equilibrium price is more pronounced in out-of-the-money than in-the-money puts, thereby steepening the implied volatility skew and resolving the puzzle. Consistent with the data, the model also implies that the equilibrium net buy of puts is decreasing in the disaster index, variance, and their price. The data shows a significant decreasing relationship between the IV skew and the net buy and no relationship in other periods, also explained by the model.

Suggested Citation

Constantinides, George M. and Lian, Lei, The Supply and Demand of S&P 500 Put Options (May 2015). NBER Working Paper No. w21161. Available at SSRN: https://ssrn.com/abstract=2604842

George M. Constantinides (Contact Author)

University of Chicago - Booth School of Business ( email )

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National Bureau of Economic Research (NBER)

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Lei Lian

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States

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