Effects of rollover strategies and information stability on the performance measures in options markets: An examination of the KOSPI 200 index options market (original) (raw)

One of the most widely used option valuation models among practitioners is the ad hoc Black-Scholes (AHBS) model. The main contribution of this paper is methodological. We carefully consider two rollover strategies (nearest-to-next strategy and next-to-next) used in the AHBS model to investigate their effect on pricing errors. We suggest a new roll-over strategy, next-to-next strategy, and demonstrate that our rollover strategy produces more consistent estimates between in-sample market and model option prices. Probably even more important is that our new roll-over strategy makes more accurate out-of-sample forecasts for 1-day or 1-week ahead prices. Prior literature has documented some anomalies associated with the use of AHBS model, for example, an overfitting problem. A secondary contribution is that our new rollover strategy does not suffer from this overfitting critique. Third, this paper uses the mean square error for out-of-sample pricing and price changes to determine how the options investors are influenced by moneyness. The results indicate that underpricing (or overpricing) by the AHBS model for the near-the-money category is more likely to be maintained for the next several trading days but that such a phenomenon is disappeared for the deep out-of-the-money category. Finally, we suggest the ratio of the number of option contracts to differences in strike prices available for trading between the current day and the previous day(s) as a good categorizing factor for options, such as moneyness.