Information Effects of Trade Size and Trade Direction: Evidence from the KOSPI 200 Index Options Market*: Information Effects of Trade Size and Trade Direction (original) (raw)
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Informed trading in the index option market: The case of KOSPI 200 options
Journal of Futures Markets, 2008
This study examines if informed trading is present in the index option market by analyzing the KOSPI 200 options, the most actively traded derivative product in the world. The spread decomposition model developed by is utilized and the adverse-selection cost component of the spread estimated by the model is then used as a proxy for the degree of informed trading. We find that adverse-selection costs constitute a nontrivial portion of the transaction costs in index options trading. Approximately one-third of the spread can be accounted for by information asymmetry costs. A further analysis indicates that adverse-selection costs are positively related with option delta. Our regression analysis shows that option-related variables are significantly associated with estimated information asymmetry costs, even when controlling for proxies for informed trading in the index futures market. Finally, we find the evidence that foreign investors are better informed compared to domestic investors and that domestic institutions have an edge in terms of information over domestic individuals.
Information flow between the stock and option markets: Where do informed traders trade?
Review of Financial Economics, 2005
This paper investigates the flow of information between the equity and options markets. We argue that informed traders, in deciding where to place their trades, are not entirely indifferent to option moneyness, degree of information asymmetry, and option liquidity. Unlike some previous studies that find information to flow unilaterally from equity to options markets, we control for the above factors and discover feedback relations between trades in out-of-the-money (OTM) options and the underlying equities. The finding is consistent with the pooling equilibrium hypothesis, which asserts that informed traders trade in both the equity and options markets. Some informed traders are probably attracted to the out-of-the money options because of their higher liquidity, lower premiums, and higher delta-to-premium ratios, hence, lending support to the liquidity and leverage hypothesis. D 2004 Elsevier Inc. All rights reserved.
Decomposing the Bid-Ask Spread of Stock Options: A Trade and Risk Indicator Model
SSRN Electronic Journal, 2000
In this paper, we develop an indicator model for option spread decomposition with explicit references to the stock market to measure the expected change in the value of an option, the trade flows of multiple option series for the modeling of a trade indicator to reflect private information signals, and the factors affecting the value an option portfolio for the modeling of three risk indicators to reflect the respective inventory risk exposure faced by the option market makers. The trade and risk indicator model is empirically tested using panel data obtained from the Australian Stock Exchange electronic limit order book. Empirical tests reveal that the adverse information component depends on the timing of trades, liquidity, option leverage, trade imbalance, and the option type. The results support multiple sources of inventory holding costs that relate to the attempt by market makers to maintain a delta neutral position and minimize their portfolio exposure to the change in the value and volatility of the underlying stock. The inventory holding costs also differ across option series and are a function of the directional change in inventory risk exposure. Decomposing the bid-ask spread of stock options: A trade and risk indicator model The historical development of equity bid-ask spread models stems from simple constructs. The theoretical framework first proposed by Demsetz (1968) explains why the bidask spread should be positive and also identifies three components-adverse information, inventory holding, and order processing. 1 These three components have also featured in subsequent empirical literature where several forms of statistical models have been constructed to estimate the components. 2 Option bid-ask spread decomposition models also recognize that the same three components are important to option market makers. The presence of information trading in the options market is well supported by the information asymmetry literature. Black (1975) documents that informed traders are attracted to the options market due to higher leverage. Easley et al. (1998) find that information-based option trading volume explains future stock price direction, and faster information flows from the options to the equity market. The presence of inventory holding costs in the options market is documented by Ho and Macris (1984). They report that option dealers adjust their quotes in response to inventory positions. 1 For a comprehensive review of the theoretical literature in bid-ask spread components, see O'Hara (1995). 2 Huang and Stoll (1997) group the various statistical models into three categories-the covariance models represented by Roll (1984), Choi et al. (1988), Stoll (1989), and George et al. (1991), that use transaction prices to estimate the effective bid-ask spread; the vector autoregressive models represented by Hasbrouck (1988, 1991) that examine the impact of inventory holding and adverse information costs on the relation between trade and quote revisions; and the trade-indicator models represented by Glosten and Harris (1988), and Madhavan et al. (1997), that use the direction of trade flows to estimate the bid-ask spread components. Subsequent to Huang and Stoll (1997), Bollen et al. (2004) present another class of statistical model to decompose the bid-ask spread into components by treating the inventory and adverse information components as an option with a stochastic time to expiration.
Modeling information linkages in the stock and options markets
Chan, F., Marinova, D. and Anderssen, R.S. (eds) MODSIM2011, 19th International Congress on Modelling and Simulation., 2011
When markets are assumed to be complete, option trading should not contain new information for market participants, as options derive their prices from the underlying stocks. However, if markets are incomplete, then this unidirectional relationship may not be true, because informed traders may prefer to trade options instead of the underlying stocks for several reasons: one, option trading involves lower transaction costs and higher financial leverage; and two, investors who have private information about stock price volatility can only make their bet on volatility in the option market. Compared with the research on the relationship between options trading activity and stock prices, there is little analysis on the information embodied in option transactions volume for stock market volatility, which undoubtedly is an important variable for risk management and portfolio allocation. This study focuses on the dynamic linkages between option trading volume and stock market volatility. We compare the significance of option trading activity in explaining the volatilities of the underlying stocks with that of stock market volume by selecting 15 New York Stock Exchange (NYSE) stocks that are most actively traded in the option markets during the period from December 11 2002 to August 31 2006. Our approach implies the following two distinctive features: • instead of the put/call volume ratio conventionally used in the literature, we measure the influence of option volume on stock market volatility by constructing the relative put (RPUT) and relative call (RCALL) ratios. • our approach also allows us to quantify the impact of option volume on the existence of persistence and asymmetry in stock market volatility. Instead of the usual generalized autoregressive conditional heteroskedasticity (GARCH) model that is commonly used to analyze the stock volume-volatility relation, we adopt Nelson's (1991) exponential GARCH (EGARCH) approach in this study. For each stock, it is noted that the trading activities in the put and call options markets have significant explanatory power for stock market volatility. In addition, the results indicate that the call options trading activity has a stronger impact on stock volatility compared with that of the put options. Our results demonstrate that information and sentiment in the option market is useful for the estimation of stock market volatility. Also, the significance of the effects of option trading activity on stock price volatility is observed to be comparable to that of stock market trading activity. Furthermore, the persistence and asymmetric effects in the volatility of some stocks tend to disappear once option trading activity is taken into account.
Informed Trading in Stock and Option Markets
The Journal of Finance, 2004
We investigate the contribution of option markets to price discovery, using a modification of Hasbrouck's (1995) "information share" approach. Based on five years of stock and options data for 60 firms, we estimate the option market's contribution to price discovery to be about 17 percent on average. Option market price discovery is related to trading volume and spreads in both markets, and stock volatility. Price discovery across option strike prices is related to leverage, trading volume, and spreads. Our results are consistent with theoretical arguments that informed investors trade in both stock and option markets, suggesting an important informational role for options.
Trade Duration, Informed Trading, and Option Moneyness
SSRN Electronic Journal, 2015
This study shows the relationship between the price impact of a trade and the duration between trades by extending a trade indicator microstructure model. Using the intraday transaction data from the KOSPI 200 options market, one of the most famous and actively traded derivatives markets in the world, we find that the price impact is greater when the trade duration is shorter for inthe-money (ITM) options, while the correlation is opposite for out-of-the-money (OTM) options. Our finding that fast trading indicates informed (noisy) trading in the ITM (OTM) options remains unchanged despite controlling for the effects of trade volume, market liquidity, and intraday time periods. There are indications that the different compositions of informed and uninformed traders in terms of option moneyness cause this result. We also find that the information content of trade duration becomes greater when informed trading is more concentrated, liquidity is lower, option maturities are longer, and the market is more volatile.
Presence of Informed Trading in Options Markets: An Experiment Using Monte Carlo Simulation
Journal of Business and Leadership, 2005
Using Monte Carlo Simulation we sltow that informed trading take place in the options market. Our results indicate that at-the-money option contracts are less likely to be information based trades. Using Black-Scholes model to evaluate call and put options, we find that with positive and negative information shocks, informed investors are better off trading out-of-the-money andlor in-the-money-options. This is clear evidence that illvestors with ills ide or superior information would take advantage of options ' leverage effect, Black (1975). Our allalysis sheds light on the direction to revisit the models proposed by Easley et al (J 998) and Chan et al (2002). We argue that, to e.xamine the role of option volume, the out-oftlte-money amI/or in-the-money option volumes should be considered as well.
SSRN Electronic Journal, 2016
The informed options trading hypothesis posits that option prices lead stock prices. In this paper, we extended the research on this hypothesis to open-market share repurchases. Empirical tests showed that the implied volatility spread was not significantly related to buy-and-hold abnormal stock returns. However, further evidence reveal a significant relationship between implied volatility spread and subsequent stock return volatility around open-market share repurchase events. We concluded that option traders have private information on the volatility of stock returns and superior information processing ability that accounts for prescient pricing behavior in options relative to stocks.
Tick Size Reduction and Price Discovery in Option Markets: An Empirical Investigation
SSRN Electronic Journal, 2000
We examine the impact of the tick size reduction introduced by the CBOE in 2007 in its second pilot program on the simultaneous price discovery process in the markets for options and their underlying securities. We first document a major dependence in both the Information Shares (IS) and Component Shares (CS) approaches to the estimation of the price discovery metrics on the inversion method of the option value to find the implied stock price. We then introduce a more accurate inversion method that results in a major increase in the information shares of option markets for both IS and CS metrics compared to the dominant Lagged Implied Volatility (LIV) inversion method. In all cases, however, we document a major impact of the tick size reduction in the option market that increases the option market information shares for all metrics and all inversion methods. other references discussed later on in the text. 4 See Chen and Gau (2009) for both futures and options. 5 The proportional option bid-ask spreads are typically more than twenty times as large as the equivalent spreads for the underlying assets, even for the most liquid index options; see also note 9.