Do Equity and Options Markets Agree about Volatility?

Abstract

We derive tight pricing kernel restrictions from options with same-day expiration (“0DTEs”). These restrictions concern the volatility of small and frequent asset price moves that the equity and options markets must agree on in a frictionless economy. Their violation leads to pseudo-arbitrage opportunities, characterized by nontrivial reward-to-risk ratios over arbitrarily short horizons and achieved by a combined position in 0DTEs and the underlying asset. Empirically, we find no evidence of feasible pseudo-arbitrage opportunities, as transaction costs, estimation risk, and short-term volatility risk prevent investors from taking advantage of small and infrequent disagreements about volatility between equity and options markets.