Index option prices embed a skew that actual price movements do not justify

Evidence

The econometrician David Bates concludes that “the substantial negative skewness and leptokurtosis16 implicit in actively traded short-maturity option prices appear fundamentally inconsistent with an absence of large weekly movements in S&P 500 futures returns over 1988-93” (Bates 2000, p. 227). “The parameter values necessary to match the smirk [skew] in S&P 500 futures options appear inconsistent with the time series properties of the stock index futures and of option prices” (Bates 2003, p. 399). — Donald MacKenzie, An Engine, Not a Camera, 911

Categorization

• XREF: connects to: Index option prices clustered around Black-Scholes values despite greater model complexity — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 786; The post-1987 volatility skew became a permanent feature of index options — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 901; A designated trader sets each day’s volatility skew by hand — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 907 (+5 more)

Broader Connections

• Option pricing theory did not describe markets but remade them in its own image #complicates (0.80) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 182