FTSE 100 PRICE PREDICTION

FTSE 100 Price Prediction with a non-linear multi-factor model

FTSE 100 Price Prediction with a non-linear multi-factor model

Introduction

Despite the importance of the London markets and the significance of the relationship for market makers, little published research is available on arbitrage between the FTSE-100 Index futures and the FTSE-100 European index options contracts. This study uses the put-call-futures parity condition to throw light on the relationship between options and futures written against the FTSE Index. The arbitrage methodology adopted in this study avoids many of the problems that have affected prior research on the relationship between options or futures prices and the underlying index. The problems that arise from nonsynchroneity between options and futures prices are reduced by the matching of options and futures prices within narrow time intervals with time-stamped transaction data. This study allows for realistic trading and market-impact costs. The feasibility of strategies such as execute-and-hold and early unwinding is examined with both ex-post and ex-ante simulation tests that take into consideration possible execution time lags for the arbitrage trade. This study reveals that the occurrence of matched put-call-futures trios exhibits a U-shaped intraday pattern with a concentration at both open and close, although the magnitude of observed mispricing has no discernible intraday pattern. Ex-post arbitrage profits for traders facing transaction costs are concentrated in at-the-money options.

FTSE 100 Price Prediction with a non-linear multi-factor model

This study uses the put-call-futures parity relationship to examine the arbitrage possibilities between FTSE-100 Index options and futures traded on the London International Financial Futures and Options Exchange (LIFFE). The London markets are among the largest in the world. LIFFE ranked as the largest European futures and options exchange by value, and the London Stock Exchange ranked as the third largest national stock market.1 Yadav and Pope (1994) examined arbitrage possibilities between futures and cash. There are, however, as yet no published studies that examine LIFFE futures-options arbitrage despite the importance of the strategy.2 As Lee and Nayar (1993, p. 890) commented, “market makers in SPX options are continually hedging their positions with the companion S&P 500 futures contracts.” By directly pricing the options contracts with the futures contracts (and vice versa), this study avoids the problems encountered in arbitraging between options or futures contracts and the underlying cash index. These problems include both high transaction and market-impact costs and the inclusion of stale prices in the index arising from the nontrading of constituent stocks. The application of the put-call-futures parity relationship for FTSE-100 contracts is possible because FTSE options and futures contracts have overlapping expiration cycles and identical underlying assets and settle, in both cases, with the exchange delivery settlement price (EDSP).3 In addition, the existence and use in this study of Europeanstyle FTSE-100 Index options (ESX) eliminate the possibility of early exercise in the option leg of the arbitrage portfolio. This study uses time-stamped bid-ask quotes and traded prices for both contracts. The data permit the matching of traded prices within narrow time intervals of ...