Market Structure, Trading Frictions, and the Profitability of Market Making in Index Options
A new study reveals market makers in S&P 500 index options earned nearly $8 billion annually from 2011 to 2022, far exceeding past estimates. Using detailed CBOE (Chicago Board Options Exchange) data and a model-free approach, researchers show most profits come from trading put options. The paper highlights the impact of trading frictions, oligopoly market structure, and regulatory changes. It calls for more transparency, noting persistent overpricing and rare losses except during crises like COVID-19.
What it examines
This paper studies how market makers in S&P 500 index options earn profits, using detailed data from 2011 to 2022. It focuses on the real-world market structure, trading frictions, and oligopoly effects, aiming to show that previous research underestimated market maker profitability by ignoring trading costs and bid-ask spreads.
What it concludes
The study finds market makers earn much higher profits than earlier estimates, mainly due to trading frictions and oligopoly power. These results suggest regulators should monitor market concentration and trading costs. The findings can help improve option pricing models and guide policy to ensure fairer, more transparent financial markets.
Evidence objects
Market makers in S&P 500 index options earned nearly $8 billion annually from 2011 to 2022vastly exceeding prior estimatesthanks to trading puts, wide bid-ask spreads, and rarely losing except during crises.
key_findings bullet 1 · key_findings · validation V0
The study challenges frictionless option pricing models, revealing that market structure, trading frictions, and a Cournot oligopoly significantly boost market maker profits, especially after regulatory changes tightened spreads post-2017.
key_findings bullet 2 · key_findings · validation V0
Using new, detailed CBOE data and a model-free stochastic dominance approach, the research exposes persistent index option overpricing, but notes limitations from lacking firm-level data and potential collusion or payment for order flow.
key_findings bullet 3 · key_findings · validation V0
This paper uniquely examines index option market structure and trading frictions, using extensive SPX and SPXW data (2011-2022) to challenge frictionless derivative models. Its empirical depth and focus on oligopolistic market makers profits reveal overlooked realities, offering novel insights valuable for both academic research and practitioners in option pricing and market microstructure.
key_findings bullet 4 · key_findings · validation V0
Raw abstract and provenance
Market Structure, Trading Frictions, and the Profitability of Market Making in Index Options Capital Markets: Market Microstructure eJournal · Follow. Capital
Source row: 1291 · abstract type: snippet