Journal of Agricultural and Resource Economics
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While considerable research has estimated liquidity costs of futures trading, little comparable research is available about options markets. This study determines effective bid-ask spreads in options and futures markets for Kansas City Board of Trade (KCBT) wheat. Effective bid-ask spreads are estimates of the actual liquidity cost of a round-trip order. Option liquidity costs are estimated using a new measure of effective spreads developed for options markets. Futures effective spreads are estimated using eight different measures developed in previous studies. Estimated effective bid-ask spreads of options contracts are at least double the effective bid-ask spreads of open-outcry futures contracts.
This study compares liquidity costs of electronic and open-outcry wheat futures contracts traded side-by-side on the Kansas City Board of Trade. Liquidity costs are considerably lower in the electronic market. Liquidity costs in the electronic market are still considerably lower after eliminating the bias created by splitting orders in the electronic market. Price volatility and transaction size are positively related to liquidity costs, while a negative relation is found between daily volume and liquidity costs. Price clustering at whole cent prices occurs in the open-outcry market which helps explain its higher liquidity costs. Daily volumes were distinctively higher during the Goldman-Sachs roll, but not enough to explain the higher liquidity costs in the open-outcry market. Trade size is larger in the open-outcry market, which suggests large traders prefer open-outcry trading.
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