Systematic Noise: Micro-movements in Equity Options Markets

TL;DR

This paper investigates the impact of systematic micro-movements, or noise, in equity options markets, revealing that a notable portion of trading volume may be attributed to modeling inaccuracies and market noise.

Contribution

It provides empirical evidence quantifying the extent of systematic noise in equity options markets, highlighting its significance in market volume and pricing discrepancies.

Findings

Approximately 1.7%-4.5% of options market volume is due to systematic noise.

Model choice can lead to different valuations, contributing to market micro-movements.

Systematic noise constitutes a significant portion of options trading activity.

Abstract

Equity options are known to be notoriously difficult to price accurately, and even with the development of established mathematical models there are many assumptions that must be made about the underlying processes driving market movements. As such, the theoretical prices outputted by these models are often slightly different from the realized or actual market price. The choice of model traders use can create many different valuations on the same asset, which may lead to a form of systematic micro-movement or noise. The analysis in this paper demonstrates that approximately 1.7%-4.5% of market volume for options written on the SPY ETF within the last two years could potentially be due to systematic noise.