TITLE:
European Options and Fixed Cost Spreads
AUTHORS:
Sunil K. Parameswaran, Sankarshan Basu
KEYWORDS:
European Options, Put-Call Parity, Fixed Cost Spreads, Generalized Method of Moments Estimation, Negative Time Value for Deep-in-the-Money Calls
JOURNAL NAME:
Theoretical Economics Letters,
Vol.13 No.3,
June
21,
2023
ABSTRACT: This paper revisits the put-call parity
condition for European options, on both
non-dividend paying and dividend paying stocks, in the presence of fixed
costs spreads. It demonstrates that the put-call parity condition becomes a set
of inequalities under these conditions. A model patterned on the Roll model for
fixed cost bid-ask spreads is postulated, and its estimation using a generalized method of moments (GMM) approach, is
suggested. Finally, the paper demonstrates
that in the presence of bid-ask spreads, European options on non-dividend-paying stocks may have a negative time
value, unlike the case of such options
in the absence of spreads. Also, due to the presence of such spreads, there could be situations, where both
calls and puts with the same exercise price are simultaneously exercised.