Arbitrage opportunities, liquidity provision, and trader types in an index option market

Chin Ho Chen*, Junmao Chiu, Huimin Chung

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

This study examines the impact of arbitrage in put–call futures parity (PCFP) violations on option market liquidity and explores the liquidity provision process by trader type during periods of arbitrage exploitation. Using a unique data set comprising the complete history of transactions, we find that PCFP violations contain toxic arbitrage opportunities. Hence, more frequent toxic arbitrage opportunities can cause liquidity to deteriorate because arbitrageurs create adverse selection costs and order imbalances in the option market. In addition, when the law of one price breaks down, market makers dominate by providing liquidity compared with individual, domestic, and foreign institutional traders.

Original languageEnglish
Pages (from-to)279-307
Number of pages29
JournalJournal of Futures Markets
Volume40
Issue number3
DOIs
StatePublished - 21 Nov 2019

Keywords

  • arbitrage
  • liquidity provision
  • put–call futures parity

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