Testing the monotoniciy Property of Option Prices


Journal of Derivatives

Winter 2006, vol. 14, n°2, pp.61-76

Departments: Finance, GREGHEC (CNRS)

Many option pricing models imply that the price of a call option is a monotonically increasing function of the value of its underlying asset, and the price of a put option is a monotonically decreasing function of the value of its underlying asset. This property is known as the monotonicity property. In this article, the author tests the empirical validity of the monotonicity property using all transaction prices in 2002 for five option contracts written on the European, British, French, German, and Swiss stock indices. The author finds that sampled intra-day option prices violate the monotonicity property 6-35% of the time. The author uncovers evidence that the frequent violations of the monotonicity property are attributable, in large part, to microstructure effects and arise from rational trading tactics