Identifying Demand and Supply in Index Option Markets

62 Pages Posted: 6 Jul 2022 Last revised: 8 Jan 2024

See all articles by Kris Jacobs

Kris Jacobs

University of Houston - C.T. Bauer College of Business

Anh Thu Mai

Purdue University Northwest; University of Houston - C.T. Bauer College of Business

Paola Pederzoli

University of Houston - C.T. Bauer College of Business

Date Written: January 5, 2024

Abstract

We identify latent demand and supply in index option markets using a sign-restricted VAR and highlight the bias from treating (equilibrium) net demand as exogenous. Market-maker supply and end-user demand are far from infinitely elastic as assumed by some models, but elasticities exceed existing estimates for equities. Characterizing supply and demand provides insights into the structure of index option markets. Deteriorating market conditions are associated with increasing option demand and decreasing option supply. The ATM (OTM) markets for calls and puts are mainly driven by demand (supply), and ATM demand and OTM supply of calls predict option and S&P500 returns.

Keywords: Latent Demand, Demand and Supply Elasticity, Index Options, Intermediaries, Market-Makers, Net Demand Pressure, Pure-Sign Restricted VAR, Covid-19 Crisis, Financial Crisis

JEL Classification: G01, G13, G14, G20

Suggested Citation

Jacobs, Kris and Mai, Anh Thu and Pederzoli, Paola, Identifying Demand and Supply in Index Option Markets (January 5, 2024). Available at SSRN: https://ssrn.com/abstract=4142582 or http://dx.doi.org/10.2139/ssrn.4142582

Kris Jacobs

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

Anh Thu Mai (Contact Author)

Purdue University Northwest ( email )

Hammond, IN 46323
United States

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

Paola Pederzoli

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

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