Weekly options are popular among exchanges worldwide recently. Starting from 2005, CBOE first introduced weekly options. NYSE Euronext, CME, and ICE also launched weekly options in 2006, 2011, and 2012 respectively. Thestrong growth for short maturity optionsin financial markets suggests that different kinds of short maturity options, such as weekly and daily options, are gradually accepted by investors around the world.For example, as CBOE decided to expand interest in weekly options in 2010, the trade volume grew from 1% of total volume to about 15%, which the average daily volume grew from less than 25,000 contracts to about 100,000 contracts in 2012. Furthermore, the types of underlying assets also expanded.
There were only a handful of weekly options of ETFs and individual stocks in 2010, while six indexes, 26 ETPs and 119 individual stocks in 2012.1In Taiwan, weekly options were introduced on Nov 2012.According toChinese National Futures Association, the average daily volume of weekly options, from the introduction to Mar 2013, accounts for 40.29% of the volume of TXO market. In addition, based on the statistics of Taiwan Futures Exchange,the volume of TXO market increased by 25%from the listing of weekly options to Feb 2013.
Prior studies document that introducing option affects the volatility of underlying assets through hedging transactions. For instance,Bansal, Pruitt, and Wei (1989) suggest that option listing in CBOE market leads to a decrease in the total (but not systematic) risk of theunderlyingfirms.Chen and Chang (2008) find that stock options listing in Taiwan decreases the degree of volatility. In contrast, Wei, Poon, and Zee (1997) find an increase in volatility for a sample of 144 OTC stocks after option listing.
In addition, introducing weekly options islikely to impact the volume and liquidity of monthly options.In practice, weekly options are less expensive than monthly options with the
1 The information related to weekly options are obtained from CBOE Weeklys splash page.
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nature of its high leverage. Also, the weekly options have the characteristics of rapid decrease of its time value and short duration. Consequently, investors using weekly options be able to tradetheir strategies more flexible than monthly options and hedge their portfoliosby using less costs. For example, option sellers may favor the use of weekly options because they take a lower risk due to the inherit characteristics ofweekly options,rapid decrease of its time value and short duration. However, investors are likely to use weekly options instead of some positions in their portfolios originally established by monthly options.This may subsequently impacts on the trade volume and liquidity of monthly options.
Despite the trades of weekly options have become popular, much less is known about the impact of its introduction on the volume and liquidity of monthly options, and the volatility of its underlying asset. The current study attempts to fill this gap.Because it is the first time to introduce short term derivativesin Taiwan, the results of the impact of weekly options onmonthly option marketand spot market may therefore be a referencefor TAIFEX to introduce other short maturity derivatives.
Another application of weekly options is strongly related to theexpiration day effects which cause abnormal trade volume and price swing duringsettlement. Chow et al. (2012) showed the expiration day effects of index futures on the cash market.Chow, Yung, and Zhang(2003)also showed the expiration day effects, a negative price effect and some return volatility, of Hang Seng Index (HSI) derivative market in Hong Kong. In order to benefit from these high volumes more frequently, stock exchanges offer short maturity derivatives.As options settled weekly, expiration day effects occur every week and traders cantake advantage of these volumes.
Prior literature has examined the impacts of introducing new derivatives on the existing markets.Kumar, Sarin, and Shastri(1995, 1998), find that option trading has some impacts on market qualities of underlying securities.Wang, Chung, and Yang (2007), based on the analysis of liquidity, suggest that the introducing E-mini futures hassignificant impact on the
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transaction prices of regular index futures, market depth deterioration, and the increase in the bid-ask spread.Chen and Chung (2011) show that the introduction of SPDR options improves the liquidity of SPDRs and reduces implicit trading costs. Liu (2007) also tests the impacts of index options on liquidity and volatility of the S&P 100 market.
This paper aims to examine the impacts of introducing weekly options on the liquidity of monthly option markets, and the price volatility of the underlying market in Taiwan.Our results help policy makers understandwhether and when to launch other short maturity derivatives in Taiwan. The primary derivativebeing researched is the TXO index option traded at the Taiwan Futures Exchange.On one hand, we focus on the impact on the trade volume and liquidity of monthly options to see whether weekly options listingimprove the liquidity of monthly options.
Since, in practice, weekly options, monthly options, and the underlying asset are traded simultaneously, we follow the simultaneous equation model (SEM)of Wang, Chung, and Yang’s (2000) with an adjustment of two dummy variables to analyze the impacts of weekly options listing on the trade volume and liquidity of monthly options and the impacts near settlement.
Our study seeks to contribute to the empirical literature of option market in Taiwan. To the best of our knowledge, this is the first empirical research to examine how weekly options affect the liquidity of monthly options in Taiwan.Many research are about the impacts of introducing derivatives on the spot market. The results suggest that introducing weekly option significantly decreases the liquidity andvolume of monthly options. This is different from other research because this paper studies the impacts on monthly options, not the whole index option market. Moreover, the price volatility of the underlying market was reduced, indicating that the introduction of weekly options stabilizes the underlying market. This isidentical to similar research in other markets.For instance, Liu (2007) showed that S&P100 stock index options can stabilize its underlying market. In addition, we adjust the raw series data of
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liquidity due possible common regularities and time trends and re-perform the SEM model.
The effects of introducing weekly option still remain same.
The later parts of this paper are arranged as follows. Section 2 reviews literature about the impacts of introducing new derivatives and expiration day effects, and also gives hypotheses in this study. Section 3 describes details of data, data sources, and methodology.
Section 4 shows the empirical results of the simultaneous equations.Section 5 is the robustness analysis. Section 6 gives the conclusion of this study and suggests the future research directions.