Price risk and bid-ask spreads of current options

Abstract

This paper investigates the spread of bid and ask prices of currency options quoted by Philadelphia Stock Exchange (PHLX) currency option specialists. Following H. Bessembinder (‘bid–ask Spreads in the Interbank Foreign Exchange Markets’, Journal of Financial Economics, Vol. 35, pp. 317–348, 1994), this paper suggests that the bid–ask spread for currency options can be attributable to inventory cost. Nonetheless, delta and gamma, among other price risk measures, are found to be the most significant explanatory variables in the bid–ask spread of currency options. Existing studies have shown that the bid–ask spreads of equity options increase with delta and gamma. This study finds that the bid–ask spread of currency options increases with delta, consistent with the existing studies on equity options. It is found, however, that the bid–ask spread decreases with gamma, in contrast to other studies.