1/ Option Trading Costs Are Lower than You Think (Muravyev, Pearson)

"Options price changes are predictable at high frequency. Effective spreads of traders who time executions are less than 40% of the size given by conventional measures."

2/ * Trades and intraday bid/ask at one-minute frequencies for all U.S. listed equity options and the underlying stocks

* Option trades ≤ 10 cents, trades for which trade direction cannot be determined, and trades during the first and last five minutes of the day are removed
3/ "Conventional measures of transactions costs are large: The effective spreads are about 80% of the size of the quoted spreads. The price impacts are also large.

"ITM options have relative (dollar) spreads that are smaller (larger) than those of options in the full sample."
4/ "The fact that the conventional measure decreased only slightly is puzzling, as option markets adopted technologies (such as algorithmic trading) that are known to have reduced transactions costs in the equity market, and equity option volume tripled during the sample period."
5/ "The BSM value [30-min MA] will differ from the midpoint if the stock price has changed but option price quotes have not been updated or if a trader is temporarily quoting aggressively.

"The difference between the BSM value and current midpoint does predict stock returns."
6/ "Overall, option price predictability as measured by R² is persistent and remains large for every month in the sample.

"Prices are less predictable when volatility is high and on earnings announcement/pre-announcement days, which are often associated with higher volatility."
7/ "We also explore the out-of-sample performance of the predictive models. Here, we do not condition on trade direction or use any other future information.

"Results indicate significant out-of-sample predictability. (At the daily horizon, R²s of more than 2% or 3% are rare.)
8/ "Overall, the analyses show that high-frequency intraday option price changes can be predicted using readily available public information. The predictability is consistent for both predictive models and is robust across moneyness categories and stocks, and over time."
9/ "Investors do actively engage in executing timing: they buy right before the price is expected to increase and sell before it is about to decrease.

"The black line shows the change in the option price midpoint from the time of a trade until ten minutes after."
10/ "Conventional measures do a poor job of estimating costs of taking liquidity for traders who time executions. (Non-timers pay the entire conventional effective half-spread.)

"Trading costs for execution timers are similar (about three cents) for all moneyness categories."
11/ From 2004-2015, "conventional effective spreads decreased only slightly. Quoted spreads increased despite improvements in technology."

"Costs for investors who time executions decreased markedly, but the cost for non-timers such as retail investors stayed flat or increased."
12/ "Half-spreads for execution timers are low for the high-liquidity portfolios: 0.3% vs. conventional effective half-spreads of 4.0%.

"Execution timing is important in all of the sorted portfolios (regardless of stock market cap, stock volatility, or quoted spread width)."
13/ This table, from the Internet Appendix, is not directly discussed in the paper. It suggests that execution timing also matters for all the option maturities examined (from 5 to 251 trading days).
14/ "If stock volatility doubles, conventional half-spreads increase by 0.2%, but algo-adjusted half-spreads decrease by 0.1% (but not economically large; stronger for non-S&P500 stocks)."

"Controlling for day-to-day differences in option characteristics do not change results."
15/ "If the price would have changed even absent the trade, only part of the price movement can be attributed to the trade itself."

"Estimates of the fair value computed using simple regression models result in price impact estimates that are smaller than conventional measures."
16/ "The volatility of portfolio 5 is five times that of portfolio 1, but the adjusted price impact is only one third larger.

"The adjusted price impact is also much less sensitive to the quoted spread than the adjusted effected spread is."
17/ "Execution timing can make a difference for the after-transaction cost profitability of options trading strategies.

"Transaction costs equal to the conventional effective (algo effective) half spread consume about 80% (40%) of the very high pre-trading cost returns."

• • •

Missing some Tweet in this thread? You can try to force a refresh

Keep Current with Darren 🥚

Darren 🥚 Profile picture

Stay in touch and get notified when new unrolls are available from this author!

Read all threads

This Thread may be Removed Anytime!


Twitter may remove this content at anytime! Save it as PDF for later use!

Try unrolling a thread yourself!

how to unroll video
  1. Follow @ThreadReaderApp to mention us!

  2. From a Twitter thread mention us with a keyword "unroll"
@threadreaderapp unroll

Practice here first or read more on our help page!

More from @ReformedTrader

5 Jan
1/ Will My Risk Parity Strategy Outperform? (Anderson, Bianchi, Goldberg)

"We gauge the potential of four strategies: value weighting, 60/40, unlevered and levered risk parity. Costs can reverse the ranking, especially when leverage is employed."

papers.ssrn.com/sol3/papers.cf… Image
2/ * U.S. stocks and U.S. Treasury bonds are inverse vol weighted (36-month rolling estimates)
* Monthly rebalancing
* Leveraged risk parity targets the ex post volatility of the market portfolio
* Trading costs are assumed to be 1% (1926-55), 0.5% (1956-70), and 0.1% *1971-2010) ImageImageImageImage
3/ "From 1926-2010, levered risk parity (financed at the 90-day T-bill rate) had the highest return. However, the performance was uneven."

NOTE: The U.S. stock/bond portfolio (no commodities) studied here may not be sufficiently diversified across asset classes. ImageImage
Read 9 tweets
4 Jan
1/ Term Structure of Short Selling Costs (Weitzner)

"Forward short selling costs (derived from put-call parity) predict future costs and stock returns. Short selling costs are higher over horizons when negative information is more likely to arrive."

2/ * Dividend payers excluded
* Cost of shorting (median across strikes) over the term of the option is back-calculated using synthetic relationships, then forward rates are calculated
* Options with negative implied shorting costs are excluded
* Spot lending data is from Markit
3/ "If earnings announcements are periods when negative information is more likely to arrive, then the term structure's shape should be affected by when an announcement takes place.

"Options that expire after the earnings announcements do have higher annualized shorting costs."
Read 11 tweets
3 Jan
New SSRN papers, January 2021
(I haven't read these yet, but they have abstracts that look interesting.)

Law of One Price in Equity Volatility Markets

Peer Momentum

December 2020 edition:
On Systematic Skewness and Stock Returns

Rivals’ Returns

Intangible Value

Is There a Value Premium in Cryptoasset Markets?
Salience Theory and the Cross-Section of Stock Returns: International and Further Evidence

Cross-section of Industry Equity Returns and Global Tactical Asset Allocation across Regions and Industries
Read 13 tweets
31 Dec 20
1/ Causal Effect of Limits to Arbitrage on Asset Pricing Anomalies (Chu, Hirshleifer, Ma)

"We examine the causal effect of limits to arbitrage using Regulation SHO, which relaxed short-sale constraints for a set of pilot stocks, as a natural experiment."

2/ "Reg SHO removed the uptick rule and bid price test on randomly selected pilot stocks.

"The SEC then eliminated short-sale price tests for all exchange-listed stocks, so SHO effectively ran from 5/2/2005 to 7/6/2007."

11 anomalies: L/S decile portfolios, equally weighted
3/ "We confirm that the pilot firms were in fact randomly assigned with respect to firm characteristics associated with the 11 anomalies.

"Results suggest that there was no significant difference between pilot and non-pilot firms prior to the announcement of the pilot program."
Read 14 tweets
29 Dec 20
1/ SPY betas of EFA, EEM, and DBC over the past ten years (contrast with TLT)... draw your own conclusions about diversification potential, etc.

(The beta measurement is a composite of metrics from three months out to five years.)

EFA: Image
2/ EEM: Image
3/ DBC: Image
Read 9 tweets
29 Dec 20
1/ Bubbles for Fama (Greenwood, Shleifer, You)

"A sharp price increase of an industry portfolio does not, on average, predict unusually low returns going forward, but such sharp price increases predict a substantially heightened probability of a crash."

papers.ssrn.com/sol3/papers.cf… Image
2/ "On average, industries that experienced a price run-up continue to go up by 7% over the next year (5% net of market) and 0% over the next two years (0% net of market).

"An *industry* run-up is also associated with poor average subsequent *market* returns." Image
3/ "If we study only cases in which a crash occurs, the average return experienced between the initial run-up and subsequent peak is 30% (107% for precious metal stocks in the late 1970s). It is difficult to bet against a bubble, even if one has correctly identified it ex-ante." Image
Read 14 tweets

Did Thread Reader help you today?

Support us! We are indie developers!

This site is made by just two indie developers on a laptop doing marketing, support and development! Read more about the story.

Become a Premium Member ($3/month or $30/year) and get exclusive features!

Become Premium

Too expensive? Make a small donation by buying us coffee ($5) or help with server cost ($10)

Donate via Paypal Become our Patreon

Thank you for your support!

Follow Us on Twitter!