Abstract

We model the supply of at-the-money (ATM) and out-of-the-money (OTM) S&P 500 index put options by risk-averse market makers (MMs) and their demand by risk-averse customers who hold the index and a risk free asset and buy puts as downside-risk protection. In equilibrium MMs are net sellers and customers are net buyers of index puts. Consistent with the data, the model-implied net buy of puts by customers is decreasing in the risk and put prices because the shift to the left of the supply curve dominates the shift to the right of the demand curve. The observed time series of the net buy of ATM and OTM puts are consistent with their model-implied counterparts.