Price discovery in the U.S. stock and stock options markets: A portfolio approach

Holowczak, Richard; Simaan, Yusif; Wu, Liuren

doi:10.1007/s11147-006-9004-0

Cited by 51 publications

(31 citation statements)

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“…For example, Chakravarty, Gulen, and Mayhew (2004) find the information share of options quotes is less than 20% on average. Holowczak, Simaan, and Wu (2006) show that the information share of options quotes is even decreasing over time, and they argue that it is due to the prevailing use of computers for automatic updating of option quotes. In a recent study, Pearson, Muravyev, and Broussard (2012) find it is option quotes, but not stock quotes, that adjust to eliminate arbitrage opportunities across the two markets.…”

Section: Background and Motivationmentioning

confidence: 99%

Does Option Trading Convey Stock Price Information?

2012

SSRN Journal

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An option market maker who executes an option order turns to the stock market to hedge away the underlying stock exposure. Thus, the stock exposure imbalance in option transactions translates directly into order imbalance in stock trades. In this paper, I decompose total order imbalance in stock transactions into the imbalance induced by option transactions and the imbalance induced by stock transactions independent of option trading activities. I find that the stock exposure imbalance induced by option transactions has strong predictive power of stock returns that does not reverse at long horizons. The independent stock order imbalance has a transitory price impact. The option-based stock return prediction increases with the level of information asymmetry, short-sale costs, and options market activity. The option-induced imbalance also predicts cumulative abnormal returns five days before earnings announcements.JEL Classification: G14, G12, G13.

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Section: Background and Motivationmentioning

confidence: 99%

Does Option Trading Convey Stock Price Information?

2012

SSRN Journal

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“…However, this relationship depends on the type of the FFA and in most cases the forward market seems to play the leading role in the price discovery process. Holowczak, Simaan and Wu (2006) investigated the price discovery process within derivatives and spot markets. They applied a portfolio based approach on option prices which consists of a long call and a short put option, resulting on a payoff which depends only on the spot prices and not on the underlying volatilities or higher moments of spot returns.…”

Section: Literature Reviewmentioning

confidence: 99%

Informational efficiency and spurious spillover effects between spot and derivatives markets

Sogiakas

Karathanassis

2015

Global Finance Journal

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1Research on the relationship between spot and derivatives markets has attracted the interest of many economists and financial analysts. According to many researchers there exists a puzzle regarding the lead-lag effect and the causality of possible spillover effects between these markets. Derivatives markets should produce the means for price discovery with a leading role in the transmission of new information. Thus, the standalone examination of the relationship of the volatility between spot and derivatives markets, does not account for possible disequilibria in the long term relationship and the informational efficiency between these markets and result in spurious spillover effects, diminishing, thus, the importance of derivatives markets as being well functioning and efficient ones. This paper uses data from three European stock market indices and contributes to the literature on the spot-derivatives spillover effects by controlling for possible disturbances in the long run equilibrium relationship between them, through a regime shift econometric approach taking into account structural breaks which are statistically and economically important.The empirical findings of the paper are in favour of the informational efficiency of these markets only partially for specific sub-periods, for which the spillover effects as well as the price discovery inherent in derivatives markets are significant.

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“…Further complicating the issue is that investors can use options to trade on different types of information. For example, investors who predict rising stock prices can take long positions in call options and short positions in put options simultaneously, whereas investors who predict 1 See, for example, Manaster and Rendleman Jr. (1982), Bhattacharya (1987), Anthony (1988), Stephan and Whaley (1990), Finucane (1991), Chan, Chung, and Johnson (1993, Easley, O'Hara, and Srinivas (1998), Jarnecic (1999), Chan, Chung, and Fong (2002), Chakravarty, Gulen, and Mayhew (2004), and Holowczak, Simaan, and Wu (2006. rising volatility can take long positions in both call and put options while minimizing their exposure to the directional movement of the stock.…”

Section: Aggregating Information In Option Transactionsmentioning

confidence: 99%

“…Most existing studies either choose one pair of option contracts (e.g., Chan, Chung, and Fong (2002) and Holowczak, Simaan, and Wu (2006)) or regard different contracts as equally informative (e.g., Easley, O'Hara, and Srinivas (1998), Cao, Chen, and Griffin (2005), and Pan and Poteshman (2006)) in inferring the directional movement of the stock price. Picking one pair of contracts while discarding all the others amounts to throwing away a large amount of information, and can potentially distort the estimated relations.…”

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confidence: 99%

Aggregating Information in Option Transactions

Holowczak¹,

Hu²,

Wu³

2014

JOD

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The listed options market in the United States trades hundreds of option contracts across different strikes and expirations for each underlying stock. The order flow from these option transactions reveals important information about the underlying stock price movement and its volatility variation. How to aggregate the trade information of different option contracts underlying the same stock presents an important challenge for developing microstructure theories and understanding price discovery mechanisms in the derivatives market. This paper takes options on QQQQ, the Nasdaq 100 tracking stock, as an example and examines different order flow aggregation methods in terms of their effectiveness in extracting information about the underlying stock price movement and its volatility variation. The analysis shows that an effective aggregation method must account for each contract's different exposure to the stock price and volatility movements, and accommodate concerns on interference from other potential risk dimensions, such as market crashes and long-term versus short-term volatility factors.The paper identifies significant relations, both contemporaneous and predictive, between the appropriately aggregated options order flow and the stock return and the return volatility. * RICHARD HOLOWCZAK is an associate professor of computer information systems at Zicklin School of Business, Baruch College. Richard.holowczak@baruch.cuny.edu.† JIANFENG HU is an assistant professor of finance at Lee Kong Chian School of Business, Singapore Management University.jianfenghu@smu.edu.sg. ‡ LIUREN WU is a professor of economics and finance at the Zicklin School of Business, Baruch College, City University of New York. liuren.wu@baruch.cuny.edu. Aggregating Information in Option TransactionsIn the absence of market frictions and under the geometric Brownian motion stock price dynamics assumed in Black and Scholes (1973) and Merton (1973), options can be perfectly replicated by a portfolio of a riskfree bond and the underlying stock. Options contracts are redundant. In reality, however, the market shows a strong demand for options for several reasons. First, the risks in the stock market cannot be completely spanned by stock trading alone. For example, the presence of discontinuous stock price movements of random size necessitates the inclusion of options across a whole spectrum of strikes to span the jump risk (Carr and Wu (2004)). The presence of stochastic volatility (Engle (2004)), on the other hand, makes the options market the de facto market for trading volatility risk (Carr and Wu (2009)).Another reason for options trading is informational. Investors can choose to trade options to gain exposure to the stock because of the high leverage provided by options (Black (1975)). Informed traders may also prefer the options market because they can better hide themselves among the multiple option contracts available on one security (Easley, O'Hara, and Srinivas (1998)).A long list of studies have investigated the information flow between...

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Price discovery in the U.S. stock and stock options markets: A portfolio approach

Cited by 51 publications

References 50 publications

Does Option Trading Convey Stock Price Information?

Does Option Trading Convey Stock Price Information?

Informational efficiency and spurious spillover effects between spot and derivatives markets

Aggregating Information in Option Transactions

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