Conventional estimates of the costs of taking liquidity in options
markets are large. Nonetheless, options trading volume is high. We
resolve this puzzle by showing that options price changes are
predictable at high frequency, and many traders time executions by
buying (selling) when the option fair value is close to the ask (bid).
Effective spreads of traders who time executions are less than 40% of
the size of conventional measures, and the overall average effective
spread is one-quarter smaller than conventional estimates. Price
impact measures are also affected. These findings alter conclusions
about the after-cost profitability of options trading strategies.
Submitted October 20, 2020 at 01:33PM by Beliavsky