Price risk and bid-ask spreads of current options

Authors: de Boyrie, Maria E¹; Kim, Yong O²; Pak, Simon J³

Source: Derivatives Use, Trading Regulation, Volume 12, Number 1, 1 May 2006 , pp. 115-125(11)

Publisher: Palgrave Macmillan

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Abstract:

This paper investigates the spread of bid and ask prices of currency options quoted by Philadelphia Stock Exchange (PHLX) currency option specialists. Following H. Bessembinder (`bid-ask Spreads in the Interbank Foreign Exchange Markets', Journal of Financial Economics, Vol. 35, pp. 317-348, 1994), this paper suggests that the bid-ask spread for currency options can be attributable to inventory cost. Nonetheless, delta and gamma, among other price risk measures, are found to be the most significant explanatory variables in the bid-ask spread of currency options. Existing studies have shown that the bid-ask spreads of equity options increase with delta and gamma. This study finds that the bid-ask spread of currency options increases with delta, consistent with the existing studies on equity options. It is found, however, that the bid-ask spread decreases with gamma, in contrast to other studies.Derivatives Use, Trading & Regulation (2006) 12, 115-125; doi:10.1057/palgrave.dutr.1840045

Document Type: Research article

DOI: http://dx.doi.org/10.1057/palgrave.dutr.1840045

Affiliations: 1: 1is an associate professor of finance at New State University. Her areas of specialisation include international finance, trade pricing and capital flight. 2: 2is an economist at Key Bank. His area of specialisation is risk management and financial derivatives. 3: 3is an associate professor of finance at the Pennsylvania State University, Great Valley School of Graduate Professional Studies. His areas of research include international trade analysis, capital flight, transfer pricing analysis and financial

Publication date: 2006-05-01