Bid-Ask Spread and Liquidity Searching Behaviour of Informed Investors in Option Markets

Abstract

We show evidence of a liquidity searching behaviour of informed investors in option listings, which was also found by Collin-Dufresne and Fos (2015) using stock markets. Nevertheless, and differently from Collin-Dufresne and Fos (2015), we find that the option bid-ask spread may be still a good proxy for informed trading, despite of the liquidity searching behaviour of informed agents. We show an upward trend in the option bid-ask spread after option introductions (as informed traders avoid trading in initial periods after listing dates due to the low liquidity environment), which is steeper for options with high chances of information asymmetries. AbstractWe show evidence of a liquidity searching behaviour of informed investors in option listings, which was also found by Collin-Dufresne and Fos (2015) using stock markets. Nevertheless, and differently from Collin-Dufresne and Fos (2015), we find that the option bid-ask spread may be still a good proxy for informed trading, despite of the liquidity searching behaviour of informed agents. We show an upward trend in the option bid-ask spread after option introductions (as informed traders avoid trading in initial periods after listing dates due to the low liquidity environment), which is steeper for options with high chances of information asymmetries.

What do we know about individual equity options?

“…Kaul et al () show evidence that informed investors trade strategically in the equity option market, taking into account the leverage and transaction costs of different option contracts. In addition, Anand and Chakravarty () present evidence of stealth trading in option markets, whereas Bernales et al () report liquidity‐searching behavior exhibited by informed investors in option markets as a means to hide their informed‐trading strategies.…”