Investor Taxes and Option Prices

We examine whether tax-sensitive investors play a significant role in options markets by examining whether option prices reflect investor taxes. Existing empirical option pricing literature ignores taxes. We exploit a unique setting where “index” options on the S&P 500 Index (SPX) and nearly identical “non-index” options on the exchange traded fund (ETF) tracking the S&P 500 Index (SPY) face different tax treatments. We find that higher investor taxes reduce option prices, indicating tax capitalization in options. We find consistent results when analyzing options around the investor tax changes enacted by the American Taxpayer Relief Act (ATRA) of 2012, and for options on stock indices other than the S&P 500 (e.g., Russell 2000). Altogether, our findings provide new evidence of an additional item – investor taxes – influencing option prices, suggesting that tax-sensitive investors play a non-trivial role in options markets and that taxes warrant consideration in broader options research.

Stochastic Bounds for Reference Sets in Portfolio Analysis

A stochastic bound is a portfolio that stochastically dominates all alternatives in a reference portfolio set instead of a single alternative portfolio. An approximate bound is a portfolio that comes as close as possible to this ideal. To identify and analyze exact or approximate bounds, feasible approaches to numerical optimization and statistical inference are developed based on linear programming and subsampling. The use of reference sets and stochastic bounds is shown to improve investment performance in representative applications to enhanced benchmarking using equity industry rotation and equity index options combinations. This paper was accepted by Kay Giesecke, finance.