Capturing the Index Effect via Options

Abstract

This article analyzes a less-known but profound impact of additions to the S&P 500: the impact on publicly traded options of the added company. The analysis shows that, in general, the changes in at-the-money option prices are profoundly higher than changes in the corresponding stock price. Comparison between the inter-index transfers and outside additions finds a far greater index effect on option prices if the underlying stocks are introduced out of the S&P 1500 index family. While it is not possible to capture most of these price changes because they happen very shortly after the announcement, the article identifies replicable trading strategies with large, statistically significant returns.

TOPICS: Options, volatility measures, statistical methods