The Crash of '87: Was It Expected? The Evidence from Options Markets

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Abstract
Transactions prices of S&P 500 futures options over 1985‐1987 are examined for evidence of expectations prior to October 1987 of an impending stock market crash. First, it is shown that out‐of‐the‐money puts became unusually expensive during the year preceding the crash. Second, a model is derived for pricing American options on jump‐diffusion processes with systematic jump risk. The jump‐diffusion parameters implicit in options prices indicate that a crash was expected and that implicit distributions were negatively skewed during October 1986 to August 1987. Both approaches indicate no strong crash fears during the 2 months immediately preceding the crash.

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