Expiration Day Effects: Empirical Evidence from Taiwan
Ju, Shiaw-En, Lo, Keng-Hsin, Wang, Kehluh, Journal of Global Business Issues
This study examines the expiration day effects of TAIEX futures and options. Empirical evidences show that abnormal volatility exists on the day before expiration day. Abnormal volume and abnormal return volatility are found in the first fifteen-minute window on the settlement. Price reversal is identified in the period from the last trading hour of the expiration day through the first fifteen minutes of trading on the settlement day. The implied volatility smile on the expiration day is significantly different from that on comparison days. Moreover, the historical volatility is negatively related to the volatility smile. Overall, the expiration effects do exist in the Taiwan market but tend to shift to the opening period of the settlement day possibly due to the market's unique settlement mechanism.
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The first stock index derivatives contracts were launched in the U.S. in the 1980s, with a unique advantage to trade or hedge broad market movements that spread quickly to other financial markets all over the world. The main advantages of the index derivatives are low trading cost and no limitations on speculation. Thus, the derivatives can be an effective hedging instrument and have the function of price discovery. However, huge order imbalances and frantic trading on the expiration day may cause the underlying stock price to temporarily deviate from equilibrium, resulting in abnormal returns, higher volatilities, price reversals and abnormal trading volume. Such expiration day effects have drawn the attention of the regulators and researchers.
There have been extensive studies on the expiration day effects in the U.S. derivatives markets. Stoll and Whaley (1986; 1987) found significant price volatility and an abnormally high volume of stock transaction on expirations days. They also found price reversal on expiration days. In June 1987, the Chicago Mercantile Exchange changed the settlement time of S&P 500 index futures and option contracts from the close of a trading day to the opening in an attempt to mitigate concerns about abnormal stock price movement at "triple witching hours". However, Stoll and Whaley (1991) and Hancock (1993) found that this new approach only shifted the expiration day effects to the opening.
The expiration day effects of index derivatives contracts in other countries also attract researchers' attention. Chamberlain, Cheung, and Kwan (1989) examined Toronto Stock Exchange (TSE) 300 index futures and found significant abnormal volume and price effect. Pope and Yadav (1992) investigated the impact of option expiration on underlying stocks in the United Kingdom. Their experiment results provided evidence in price effect but no significant result was found regarding abnormal return volatility. Swidler, Schwartz and Kristiansen (1994) studied the expiration day effects of options on underlying security traded on the Oslo Stock Exchange. They found evidence of downward price pressure on the underlying stocks on expiration days with a rebound of prices on the following day. Schlag (1996) examined expiration day effects of stock index derivatives in Germany and suggests there was a significant increase in trading volume on expiration days but return volatility remained unchanged around the expiration days. Karolyi (1996) studied Nikkei 225 futures contract expirations and concludes that the expiration of the futures results in abnormal trading volume while significant price effect did not exist. Stoll and Whaley (1997) examined expiration day effects of All Ordinaries Share Price Index (SPI) futures traded on the Sydney Futures Exchange. Their investigations indicated that abnormally high trading volume occured near the close on expiration days but no significant price effects were found around expiration days. Corredor, Lechon and Santamaria (2001) analyzed the expiration day effect of the Ibex-35 derivatives listed on the Spanish Equity Derivatives Exchange. …