Liquidity of the CBOE Equity Options

Authors

  • ANAND M. VIJH

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    • Assistant Professor, University of Southern California, Los Angeles. This paper is based on the fourth essay of my dissertation completed at the University of California, Berkeley. I am obliged to Mukesh Bajaj, Tim Campbell, Gregory Connor, Larry Harris, Terry Marsh, and Mark Rubinstein (dissertation advisor) for helpful comments. I am especially obliged to the referee and the editor for many helpful suggestions which improved this paper considerably.


ABSTRACT

We examine the CBOE option market depth and bid-ask spreads. Absence of price effects surrounding large option trades suggests excellent market depth. However, bid-ask spreads for the CBOE options and the NYSE stocks are nearly equal, even though an average option is equivalent to less than half a stock plus borrowing. We explain this tradeoff between market depth and bid-ask spreads on the CBOE and the NYSE by differences in market mechanisms. We also show that the adverse-selection component of the option spread, which measures the extent of information-related trading on the CBOE, is very small.

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