The Supply and Demand of S&P 500 Put Options
We document that the implied volatility skew of S&P 500 index puts is non-decreasing in the disaster index and risk-neutral variance, contrary to the implications of a broad class of no-arbitrage models. The key to the puzzle lies in recognizing that, as the disaster risk increases, customers demand more puts as insurance while market makers become more credit-constrained in writing puts. The resulting increase in the equilibrium price is more pronounced in out-of-the-money than in-the-money puts, thereby steepening the implied volatility skew and resolving the puzzle. Consistent with the data, the model also implies that the equilibrium net buy of puts is decreasing in the disaster index, variance, and their price. The data shows a significant decreasing relationship between the IV skew and the net buy and no relationship in other periods, also explained by the model.
We thank David Bates, Michal Czerwonko, Zhiguo He, Jens Jackwerth, Nikunj Kapadia, Stylianos Perrakis, Alexi Savov, Myron Scholes, and Dacheng Xiu for helpful comments. Constantinides acknowledges financial support from the Center for Research in Security Prices of the University of Chicago, Booth School of Business. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.