TY - JOUR

T1 - The Impact of a Premium-Based Tick Size on Equity Option Liquidity

AU - Verousis, Thanos

AU - ap Gwilym, Owain

AU - Voukelatos, Nikolaos

PY - 2016/3/7

Y1 - 2016/3/7

N2 - On June 2, 2009, NYSE LIFFE Amsterdam reduced the tick size for options trading at prices below € 0.20 from € 0.05 to € 0.01 and on April 1, 2010, the exchange increased the price threshold to € 0.50. We study the effect of that tick size reduction on the liquidity of individual equity options. In this respect, this study is uniquely positioned in the options context where moneyness is a clear additional factor in the implementation of the tick size changes. We show that, in general, quoted and traded option liquidity increased but at a rate decreasing with option moneyness. Real costs fell more for the lower priced contracts. Importantly, we show that the ability of the market to absorb larger trades has potentially diminished after the change in the tick size. We document a substantial increase in quote revisions which implies an increase in price competition and, as a result, an improvement in market quality. Finally, the decrease in the tick size led to an increase in hedging activity using deep-out-of-the-money puts.

AB - On June 2, 2009, NYSE LIFFE Amsterdam reduced the tick size for options trading at prices below € 0.20 from € 0.05 to € 0.01 and on April 1, 2010, the exchange increased the price threshold to € 0.50. We study the effect of that tick size reduction on the liquidity of individual equity options. In this respect, this study is uniquely positioned in the options context where moneyness is a clear additional factor in the implementation of the tick size changes. We show that, in general, quoted and traded option liquidity increased but at a rate decreasing with option moneyness. Real costs fell more for the lower priced contracts. Importantly, we show that the ability of the market to absorb larger trades has potentially diminished after the change in the tick size. We document a substantial increase in quote revisions which implies an increase in price competition and, as a result, an improvement in market quality. Finally, the decrease in the tick size led to an increase in hedging activity using deep-out-of-the-money puts.

U2 - 10.1002/fut.21734

DO - 10.1002/fut.21734

M3 - Article

VL - 36

SP - 397

EP - 417

JO - Journal of Futures Markets

JF - Journal of Futures Markets

SN - 0270-7314

IS - 4

ER -