RDP 8902: Option Prices and Implied Volatilities: An Empirical Analysis 3. Data Employed

Our data set on futures options comprises weekly observations on the three major contracts traded on the Sydney Futures Exchange (in 90-day bills, 10-year bonds, and the Share Price Index), with the data period running from the inception of trading in each option up to the end of May 1988, using Wednesday observations. At each date a single put and call option are selected, in each case choosing the option most heavily traded on that day. The reason for using this criterion is that most of the SFE options quoted at a point in time are not actively traded, and the study aims to derive its results only from those options which are most liquid. Also, volatilities derived from puts and calls are tested separately because there is some evidence (see for example Brenner, Courtadon and Subrahmanyam (1985)) of significantly different results for the two types of options. The approach used here thus differs slightly from some earlier work which uses weighted averages of implied volatilities taken from several options at each date.

The options used in the study are always written on the nearest maturing futures contract (or the following one, when the maturity date is very near) and have the same expiry date as their associated futures contracts. They thus range between zero and about 90 days to maturity. On one observation each 90 days, it is not possible to observe the relationship described in equation (6), since the consecutive weekly observations will be for options with differing maturity dates. “New contract” dummies at these points are therefore added to the equation for the purposes of estimation. These ensure that observations coinciding with contract changeovers have no influence on the statistical results. A helpful consequence of selecting only the most heavily traded options is that these are generally the available options that are nearest the money. Pricing biases arising from violation of the Black-Scholes assumptions should therefore be minimised in this data set, since it is generally thought that the Black-Scholes formula performs worst for options which are not close to the money.

The currency options data are weekly Wednesday quotes for at-the-money put and call options on the $A/US$ exchange rate, of one month maturity. The data period is from December 1984 to December 1987.