Do Price Limits Limit Price Discovery in the Presence of Options?

39 Pages Posted: 5 Sep 2006  

David Reiffen

U.S. Commodity Futures Trading Commission (CFTC)

Bahattin Buyuksahin

Bank of Canada

Michael S. Haigh

Standard Chartered Bank

Date Written: September 20, 2006

Abstract

We examine the effect of price limits on futures contracts where there exist options contracts on those futures that have no price limits. We establish that when options are trading, the futures price implied by put-call parity provides an accurate prediction of the unconstrained futures price. We also provide empirical evidence that futures trading volume decreases on limit hit days, and that some of this decline is effectively transferred to the options market. These facts suggest that price discovery shifts to the options market when limit hits occur on the futures market. We also document that the microstructure of the future's market on the next day is affected positively by the presence of options on limit days, as the presence of options lowers spreads and reduces intra-day price variability. In total, we find that options assist in price discovery in the presence of limits.

Keywords: price limits, price discovery, options, futures

JEL Classification: G13, G18

Suggested Citation

Reiffen, David and Buyuksahin, Bahattin and Haigh, Michael S., Do Price Limits Limit Price Discovery in the Presence of Options? (September 20, 2006). Available at SSRN: https://ssrn.com/abstract=928013 or http://dx.doi.org/10.2139/ssrn.928013

David Reiffen (Contact Author)

U.S. Commodity Futures Trading Commission (CFTC) ( email )

Three Lafayette Centre
1155 21st Street, NW
Washington, DC 20581
United States

Bahattin Buyuksahin

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

Michael Stephen Haigh

Standard Chartered Bank ( email )

6 Battery Rd
049909
Singapore
65-8838-7318 (Phone)

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