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. (JEL G13, G14).
ASJC Scopus subject areas
- Economics and Econometrics