This study examines possible expiration-day effects of the KOSPI 200 futures and options contracts. Specifically, we investigate the behavior of the KOSPI 200 on the days when the KOSPI 200 futures or options contracts expire. Since arbitrageurs have to close out their positions in these index derivatives on expiration days, large volumes of stocks comprising KOSPI 200 are likely to be traded near the closing time on the expiration days. If there are a large number of arbitrageurs employing computer-assisted program trades to unwind index arbitrage positions, order imbalances in the component stocks can lead to an abnormal increase in stock volatility. Unless, coincidentally, some significantly fundamental information arrives regarding certain KOSPI 200 stocks near the expiration, such an aberration in a cash stock market usually implies that the market is experiencing a stress in absorbing a temporary increase in trading volume on an expiration day. Recognizing the possibility of this undesirable expiration-day effect, regulators are keen to prevent any adverse increase in the cash stock market volatility that results from expiration-related trading. Using the minute-by-minute data covering the sample period from July 14, 1997 to July 9, 2004, we examine the trading volume and price behavior of the KOSPI 200. In order to investigate intraday index behavior around expiration days, we divide each trading day into six 30-minute periods. We find that the trading volume of KOSPI 200 stocks significantly increases during the last 30 minutes before the expiration of the KOSPI 200 futures or options. We also find that the volatility of the returns to KOSPI 200 stocks rises significantly during the same 30-minute period before the expiration. However, such increases in trading volume and return volatility cannot be simply attributed to the expiration day effect if they were mainly driven by new arrival of fundamental information about certain KOSPI 200 stocks coinciding with the expiration. To ascertain this possibility, we check if there are price reversals around the expiration days. The logic behind this test is based on the conjecture that a temporary and abnormal increase in trading volume of the KOSPI 200 stocks pushes stock prices to an abnormally high or low level near the expiration day, and that the market corrects itself on the following day by reversing stock prices to recover the normal level. Our empirical results show statistically significant price reversals around the expiration days. Thus, we interpret that the aberration in stock trading volume and volatility observed near the closing time on expiration days results mainly from the arbitrageurs' closing-out activities. The aberrations found on expiration days of the index futures and options reflect a weakness of the Korean stock market in that stock prices are likely to be swung by the factors not related to the fundamental information regarding the stocks comprising the KOSPI 200. Such expiration-day volatility is generally not found in other stock markets. Our research results entail interesting future research topics including an exploration of factors that make the Korean stock market susceptible to expiration-day effects. On the regulatory front, there should be policy measures in force to reduce undesirable expiration-day effects. One of necessary steps toward making the Korean stock market less susceptible would be attracting long-term institutional investors to the Korean stock market. Encouraging indirect investing through mutual funds would also help.
