Option Trading and REIT Returns

Abstract

This article examines the relation between option trading volume and real estate investment trust (REIT) market performance. Specifically, we find that option volume increases are followed by decreases in returns. Furthermore, the portion of option volume that is orthogonal to REIT characteristics drives the observed return predictability relation, thereby suggesting that the return predictability of option trading is (at least partially) attributable to information‐based explanations. Finally, consistent with informed traders favoring option market activities due to short‐sale costs and/or constraints, we find option based return predictability is more evident within REITs than non‐REITs, even though firms within this industry are generally viewed as informationally transparent.

Short selling and options trading: A tale of two markets

“…Turning to our option measures, following Cashman et al (2021), we use options (across all strike prices) expiring within the next 35 trading days. Furthermore, to minimize mechanical issues related to option trading volume associated with contract roll forward, we exclude options expiring within the next 5 trading days.…”

“…We note, however, that an average size of $8.1 billion is consistent with prior studies examining the REIT options market. For comparison, Cashman et al (2021) report an average size of $7.6 billion for REITs with active options trading. Finally, our average option‐to‐stock‐volume ratio reported in Panel B (2.9%) is consistent with that found in the literature (3.0%; see, e.g., Johnson & So, 2012).…”

“…To explore the relative predictive power across, and interactions between, these two markets, we next incorporate the option metrics and additional controls employed by Cashman et al (2021) into our multivariate short‐selling model specifications. The key additions in this new framework are the inclusion of relative option trading volume (i.e., O/S spread) and the interaction terms, both between option volume and short‐selling risk as well as between option volume and short interest.…”

“…Finally, and further highlighting the usefulness of this market sector as our laboratory, a small handful of papers document the predictive power of both short selling and options volume within the REIT market (e.g., Cashman et al, 2021; Chen et al, 2012; French et al, 2012; Li & Yung, 2004). Although these investigations strongly support the existence of informed traders within this market segment, they offer little insight into the nature of these competing venues as the desired location for informed trading.…”

Real estate as a new equity market sector: Market responses and return comovement

“…A potential extension to our study is to examine changes in derivatives trading behavior after the reclassification. For example,Cashman, Harrison, and Sheng (2018) find that option volume increases are followed by decreases in REIT returns.…”