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The Favorite/Long-Shot Bias in S&P 500 and Ftse 100 Index Futures Options: The Return to Bets and the Cost of Insurance

Last Updated on 10 February, 2024 by Rejaul Karim

Detailing a compelling foray into the capricious terrain of betting biases and insurance costs, the research paper “The Favorite/Long-Shot Bias in S&P 500 and Ftse 100 Index Futures Options: The Return to Bets and the Cost of Insurance” authored by Stewart D. Hodges of the University of Warwick, Robert Tompkins of the Business School of Finance & Management and William T. Ziemba of the University of British Columbia surmises a revelatory investigation into porting the favorite/long-shot bias endemic in gambling markets, particularly horse racing, to options markets.

Spanning seventeen-plus years from March 1985 to September 2002, the research divulges the striking resonance of probabilities and average returns akin to the favorite/long-shot bias in horse racing markets, particularly discernible in calls on the FTSE 100 futures with three months to expiration.

Notably, the paper divulges slight profits from deep in-the-money calls on the S&P 500 futures, juxtaposed against escalating losses from out-of-the-money calls, alongside asserting the existence of a significant long-shot bias for deep out-of-the-money options on the FTSE 100 futures.

The acute revelation of a long-shot bias in one-month horizon call options adds a layer of intrigue, shadowing the alarmingly consistent tendency toward overpaying for put options hued by the premise of an expected cost of insurance.

Enveloped by an analogous pattern to the favorite/long-shot bias pervading racing markets, the enigmatic canvas of options on the British Pound/US Dollar elicits a departure from systematic favorite/long-shot bias for both calls and puts, casting a tapestry of profound disquisitions within the options ecosystem.

Abstract Of Paper

This paper examines whether the favorite/long-shot bias that has been found in gambling markets (particularly horse racing) applies to options markets. We investigate this for the S&P 500 futures, the FTSE 100 futures and the British Pound/US Dollar futures for the seventeen plus years from March 1985 to September 2002. Calls on the FTSE 100 with three months to expiration display a relationship between probabilities and average returns that are very similar to the favorite/long-shot bias in horse racing markets pointed out by Ali (1979), Snyder (1978) and Ziemba & Hausch (1986). There are slight profits from deep in-the-money calls on the S&P 500 futures and increasingly greater losses as the call options are out-of-the-money. For 3 month calls on the FTSE 100 futures, the favorite bias is not found, but a significant long-shot bias has existed for the deepest out of the money options. For call options in both markets, for the one month horizon, only a longshot bias is found. For the put options on both markets, and for both 3 month and 1 month horizons, we find evidence consistent with the hypothesis that investors tend to overpay for all put options as an expected cost of insurance. The patterns of average returns is analogous to the favorite/longshot bias in racing markets. For options on the British Pound/US Dollar, there does not appear to be any systematic favorite/long-shot bias for either calls or puts.

Original paper – Download PDF

Here you can download the PDF and original paper of The Favorite/Long-Shot Bias in S&P 500 and Ftse 100 Index Futures Options: The Return to Bets and the Cost of Insurance.

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Author

Stewart D. Hodges
University of Warwick – Financial Options Research Centre (FORC)

Robert Tompkins
Business School of Finance & Management (HfB) – Bankakademie Group

William T. Ziemba
University of British Columbia (UBC) – Sauder School of Business; Systemic Risk Centre – LSE

Conclusion

In a resounding denouement, the research paper “The Favorite/Long-Shot Bias in S&P 500 and Ftse 100 Index Futures Options: The Return to Bets and the Cost of Insurance” meticulously etched by Stewart D. Hodges, Robert Tompkins, and William T. Ziemba ushers in an epochal culmination, unveiling a profound medley of insights into the eddying labyrinth of betting biases and insurance costs in options markets.

Cascading across seventeen-plus years, the paper espouses a compelling alignment of probabilities and average returns, redolent of the entrenched favorite/long-shot bias in horse racing markets, splendidly mirrored by calls on the FTSE 100 futures with a three-month expiration.

Illuminative is the revelation of slight profits from deep in-the-money calls on the S&P 500 futures, counterpoised by escalating losses from out-of-the-money calls, alongside the consolidated existence of a significant long-shot bias for deep out-of-the-money options on the FTSE 100 futures.

Layered with intrigue is the disclosure of a long-shot bias in one-month horizon call options, accompanied by the constancy of overpricing for put options tethered to the premise of an expected cost of insurance, enshrining an analogous pattern to the favorite/long-shot bias permeating racing markets.

Evocatively, the ethereal realm of options on the British Pound/US Dollar diverges from systemic favorite/long-shot bias, bequeathing an eclectic panorama of fervid discussions within the guise of the options universe, signifying an indelible opus that impels an indomitable vista of erudition and intrigue.

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FAQ

1. What is the main focus of the research paper “The Favorite/Long-Shot Bias in S&P 500 and Ftse 100 Index Futures Options: The Return to Bets and the Cost of Insurance”?

The primary focus of the research paper is to investigate whether the favorite/long-shot bias observed in gambling markets, particularly in horse racing, is applicable to options markets. The study spans over seventeen years, from March 1985 to September 2002, and examines the S&P 500 futures, FTSE 100 futures, and British Pound/US Dollar futures. It explores the relationship between probabilities and average returns in different options scenarios, shedding light on biases and insurance costs inherent in these markets.

2. What are some key findings and patterns highlighted in the research paper regarding biases in S&P 500 and FTSE 100 Index Futures Options?

The paper reveals several noteworthy findings. In the case of FTSE 100 futures options with three months to expiration, there is a resemblance to the favorite/long-shot bias in horse racing markets. Profits are noted from deep in-the-money calls on S&P 500 futures, while losses escalate for out-of-the-money calls. Interestingly, a significant long-shot bias is observed for deep out-of-the-money options on FTSE 100 futures. The study also points out a long-shot bias in one-month horizon call options and identifies a consistent tendency of overpaying for put options, attributed to the expected cost of insurance.

3. How does the research paper contribute to our understanding of biases and patterns in options markets, and what distinguishes the behavior of options on the British Pound/US Dollar from other markets?

The research paper contributes significantly to understanding biases and patterns in options markets by providing a comprehensive analysis spanning multiple years. The findings indicate a nuanced alignment with the favorite/long-shot bias observed in horse racing markets, especially in FTSE 100 futures options. The paper distinguishes the behavior of options on the British Pound/US Dollar by revealing a lack of systematic favorite/long-shot bias for both calls and puts. This divergence prompts further discussions within the options universe, offering a unique perspective on the dynamics of these financial instruments.

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