The Impact of Option Listing on Underlying Stock Returns: The Uk Evidence

Abstract

INTRODUCTIONThis paper analyses UK evidence on the impact of option listing on the returns' process of underlying stocks. In particular, it examines the existence of 'abnormal returns', and the effect of option listing on the systematic risk, unsystematic risk, total risk, skewness and kurtosis of the returns' distribution, as well as the effect on the efficiency of adjustment of prices to new information.We find that option listing is associated with a temporary price increase immediately prior to listing, as against the permanent price increase observed in US markets. Consistent with earlier US based studies, we also find lower unsystematic risk and lower total risk in post-listing daily returns and no change in average beta. The decline in unsystematic and total risk is largely confined to stocks with high pre-listing volatility. Using a simple model for price behaviour allowing for market structure and information related noise, as well as imperfect price adjustment to value changes, we find that there is an increase in the efficiency with which prices adjust to new information. A significant decline is also observed in skewness of returns and this is consistent with the hypothesis that the introduction of put options increases the speed with which negative information is incorporated into prices. Overall, the results suggest that the options market is making a significant contribution to the efficiency of financial markets by reducing risk and improving the adjustment of prices to new information.This paper is organised as follows: the next section provides the background and motivation for the research; the third section describes the methodology and documents the empirical results; and the final section presents the conclusions. BACKGROUND AND MOTIVATION

The Impact of Warrant Introduction: The Australian Experience

“…In contrast to Draper et al (2000), but in support of Conrad (1989), Watt, Yadav & Draper (1992) find lower variance and no change in beta in the UK market. GARCH modelling techniques and a control sample methodology, they found a general reduction in the volatility as well as a decrease in systematic risk.…”

“…If this were the explanation, then the price movement should reverse subsequent to listing as demand pressures decrease. The findings of Draper et al (2001) and Watt et al (1992) more accurately reflect this process. same findings.…”

“…same findings. The UK market has been examined by Watt, Yadav & Draper (1992) and Faff & Hillier (2003). Both find positive price impacts, but again that the effect is only temporary.…”

“…In summary, the impact derivative option listing has on the underlying securities price is varied across studies and time. Early studies by Conrad (1989), Haddad & Vorrheis (1991) and Watt, Yadav & Draper (1992) The general frameworks that explain the impact of option introduction predict positive impacts on volume. The complete market theory suggests that new investors will be drawn to the underlying security because of improved opportunity sets, whilst the improved information environment theory predicts that increased profile associated with option introduction will encourage new investors, but at the potential cost of informed traders leaving the stock market to access the benefits found in the options market.…”

Market risk and the concept of fundamental volatility: Measuring volatility across asset and derivative markets and testing for the impact of derivatives markets on financial markets

“…see Trennepohl and Dukes (1979), Skinner (1989), Conrad (1989), Detemple and Jorion (1990), Damodaran and Lim (1991), Haddad and Voorheis (1991), Watt, Yadav and Draper (1992), Chamberlain, Cheung and Kwan (1993), and Gjerde and Saettem (1995) 20 .…”