Author(s)

Siyi Fan, Chen Ai

Corresponding Author

Siyi Fan

ABSTRACT

In this paper, the importance of detecting the mispricing in option market, and some methods to test the mispricing which includes the boundary violation, convexity and exercise price violation, the relationship between option lives and prices violation, put-call parity and Black-Scholes model (BSM) together with implied volatility in Chicago Board Options Exchange were also studied. Trading strategies to exploit the mispricing were also suggested in this paper. Based on our data, more violations were found on call options except for strike price violation. Also, the violation frequency of the options in aspect of boundary violation was found to be sensitive to the stock price. Only little attention was recommended to be puton the violation of convexity and time to maturity due to less profit compared with transaction cost. However, the violations of exercise price were considered to be relatively serious given the reason of certain high degree of mispricing based on the theoretical price. With reference to put-call parity and BSM violations, they were both frequently detected and should be seriously considered. And for BSM, most of the pricing errors of call options appeared with larger moneyness, while most of the pricing errors of put options appeared with smaller moneyness. In conclusion, more attention should be suggested to be put on exercise price conditions, put-call parity and BSM violations.

KEYWORDS

Trading strategies, price violations, Chicago Board Options Exchange, Black-Scholes model