39 Pages Posted: 5 Sep 2006
Date Written: September 20, 2006
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: 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
By Paul Kupiec