The Index Effect: Evidence from the Option Market
60 Pages Posted: 7 Jan 2021 Last revised: 17 Apr 2023
Date Written: January 7, 2021
Equity option markets react significantly to S&P 500 index inclusion news. We document a strong and temporary increase in call option trading volume shortly after the announcement. In the one-day event window, delta-hedged call options yield a statistically significant placebo- and risk-adjusted return of 0.90%. Increases in implied volatility account for a large part of the announcement effect. The effect is stronger for options that provide more leverage and reverses over time. Overall, the results are consistent with the demand-based theory of option pricing.
Keywords: G10, G12, G14
JEL Classification: Delta-Hedged Options, Demand Pressure, Index Effect, Placebo
Suggested Citation: Suggested Citation