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The Favorite/Long-Shot Bias in S&P 500 and Ftse 100 Index Futures Options: The Return to Bets and the Cost of Insurance

22 Pages Posted: 23 Jul 2003  

Stewart D. Hodges

University of Warwick - Financial Options Research Centre (FORC)

Robert Tompkins

Business School of Finance & Management (HfB) - Bankakademie Group

William T. Ziemba

University of British Columbia (UBC) - Sauder School of Business

Abstract

This paper examines whether the favorite/long-shot bias that has been found in gambling markets (particularly horse racing) applies to options markets. We investigate this for the S&P 500 futures, the FTSE 100 futures and the British Pound/US Dollar futures for the seventeen plus years from March 1985 to September 2002. Calls on the FTSE 100 with three months to expiration display a relationship between probabilities and average returns that are very similar to the favorite/long-shot bias in horse racing markets pointed out by Ali (1979), Snyder (1978) and Ziemba & Hausch (1986). There are slight profits from deep in-the-money calls on the S&P 500 futures and increasingly greater losses as the call options are out-of-the-money. For 3 month calls on the FTSE 100 futures, the favorite bias is not found, but a significant long-shot bias has existed for the deepest out of the money options. For call options in both markets, for the one month horizon, only a longshot bias is found. For the put options on both markets, and for both 3 month and 1 month horizons, we find evidence consistent with the hypothesis that investors tend to overpay for all put options as an expected cost of insurance. The patterns of average returns is analogous to the favorite/longshot bias in racing markets. For options on the British Pound/US Dollar, there does not appear to be any systematic favorite/long-shot bias for either calls or puts.

Keywords: long-shot bias, gambling, option prices, implied volatilities

JEL Classification: C15, G13

Suggested Citation

Hodges, Stewart D. and Tompkins, Robert and Ziemba, William T., The Favorite/Long-Shot Bias in S&P 500 and Ftse 100 Index Futures Options: The Return to Bets and the Cost of Insurance. EFA 2003 Annual Conference Paper No. 135; Sauder School of Business Working Paper. Available at SSRN: https://ssrn.com/abstract=424421 or http://dx.doi.org/10.2139/ssrn.424421

Stewart D. Hodges

University of Warwick - Financial Options Research Centre (FORC) ( email )

Warwick Business School
Coventry CV4 7AL
United Kingdom
01203-523606 (Phone)

Robert George Tompkins (Contact Author)

Business School of Finance & Management (HfB) - Bankakademie Group ( email )

Frankfurt
Germany
(069) 154008-718 (Phone)

William T. Ziemba

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
604-261-1343 (Phone)
604-263-9572 (Fax)

HOME PAGE: http://williamtziemba.com

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