S & P 500 Index Option Tests of Tarrow and Rudd ’ S Approximate Option Valuation Formula

The Black-Scholes ( 1973) option pricing model is a universal standard among option valuation models. Despite its widespread popularity, however, the model has some known deficiencies in actual applications. For example, when calibrated to accurately price at-the-money options, the Black-Scholes model frequently misprices deep in-the-money and deep out-of-the-money options. Pricing biases associated with the Black-Scholes option pricing model are well documented. Well-known studies by Black (1975), Emanuel and MacBeth (1982), MacBeth and Merville ( 1 979), and Rubinstein (1985, 1994) all report that the Black-Scholes model tends to systematically misprice in-the-money and out-of-themoney options. Rubinstein (1994) also points out that strike price biases associated with the Black-Scholes model have been especially severe for S&P 500 index options since the October 1987 market crash and that