An analysis of index option pricing

A study was conducted to extend and expand previous research on index option pricing. The primary purpose of the study was to evaluate the Black-Scholes (1973) option pricing model with respect to the pricing of call options on the Standard and Poor's (S&P) 100 Index. Historical and implied...

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Bibliographic Details
Published in:The journal of futures markets 1989-10, Vol.9 (5), p.449-459
Main Authors: Cotner, John S., Horrell, James F.
Format: Article
Language:English
Subjects:
Economic models
Market prices
Multivariate analysis
Options markets
Options trading
Put & call options
Stochastic models
Studies
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Summary:A study was conducted to extend and expand previous research on index option pricing. The primary purpose of the study was to evaluate the Black-Scholes (1973) option pricing model with respect to the pricing of call options on the Standard and Poor's (S&P) 100 Index. Historical and implied variance estimates were compared to determine their effect on pricing errors. The analysis considered 108 distinct options over a 27-month period. It was found that the level of the risk-free rate of interest, the level of the index return variance estimate, and the level of an option's "moneyness" all have statistically significant effects on the level of the mean pricing errors. On average, the Black-Scholes model provides an unbiased estimate of the market price of options on the S&P 100 Index when the implied variance estimate is used. However, there is a significant positive bias indicated in the model when the historical estimate of variance is used in combination with longer maturities.
ISSN:0270-7314
1096-9934
DOI:10.1002/fut.3990090507