Implied Volatility Adjustments After Jumps in S&P 500 Returns

Summary

This study examines whether S&P 500 option implied volatility adjusts immediately when the underlying index experiences a return jump. Using minute-by-minute index option data, it tracks implied volatility after jumps to test whether gradual changes are consistent with delayed market adjustment. The reported movements are directed and persistent, particularly after negative jumps.

The findings differ across option moneyness and type: implied volatility from at-the-money options and out-of-the-money puts moves gradually, while the measure from out-of-the-money calls reaches its new level immediately. This points to an asymmetric adjustment of the implied volatility smile. The authors note that these patterns could support statistical arbitrage in a hypothetical zero-transaction-cost market. However, when actual option bid-ask spreads are considered, the results do not indicate abnormal option returns. The evidence therefore describes a market response pattern, not a demonstrated profitable trading strategy after trading costs.

Key ideas

• The study uses minute-level S&P 500 index option data to examine implied volatility after return jumps.
• Implied volatility changes are delayed and persistent after jumps, especially after negative jumps.
• At-the-money options and out-of-the-money puts show gradual adjustment, while out-of-the-money calls adjust immediately.
• The implied volatility smile responds asymmetrically across option types.
• The reported patterns do not imply abnormal returns once actual option spreads are considered.

Tags

# Option market (in)efficiency and implied volatility dynamics after return jumps


# Option market (in)efficiency and implied volatility dynamics after return jumps









In informationally efficient financial markets, option prices and this implied volatility should immediately be adjusted to new information that arrives along with a jump in underlying's return, whereas gradual changes in implied volatility would indicate market inefficiency. Using minute-by-minute data on S&P 500 index options, we provide evidence regarding delayed and gradual movements in implied volatility after the arrival of return jumps. These movements are directed and persistent, especially in the case of negative return jumps. Our results are significant when the implied volatilities are extracted from at-the-money options and out-of-the-money puts, while the implied volatility obtained from out-of-the-money calls converges to its new level immediately rather than gradually. Thus, our analysis reveals that the implied volatility smile is adjusted to jumps in underlying's return asymmetrically. Finally, it would be possible to have statistical arbitrage in zero-transaction-cost option markets, but under actual option price spreads, our results do not imply abnormal option returns.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.