IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/10925.html
   My bibliography  Save this paper

The Information of Option Volume for Future Stock Prices

Author

Listed:
  • Jun Pan
  • Allen Poteshman

Abstract

We present strong evidence that option trading volume contains information about future stock price movements. Taking advantage of a unique dataset from the Chicago Board Options Exchange, we construct put-call ratios from option volume initiated by buyers to open new positions. On a risk-adjusted basis, stocks with low put-call ratios outperform stocks with high put-call ratios by more than 40 basis points on the next day and more than 1% over the next week. Partitioning our option signals into components that are publicly and non-publicly observable, we find that the economic source of this predictability is non-public information possessed by option traders rather than market inefficiency. We also find greater predictability from option signals for stocks with higher concentrations of informed traders and from option contracts with greater leverage.

Suggested Citation

  • Jun Pan & Allen Poteshman, 2004. "The Information of Option Volume for Future Stock Prices," NBER Working Papers 10925, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:10925
    Note: AP
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w10925.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. M. B. Haugh & A. W. Lo, 2001. "Asset allocation and derivatives," Quantitative Finance, Taylor & Francis Journals, vol. 1(1), pages 45-72.
    2. David Easley & Soeren Hvidkjaer & Maureen O'Hara, 2002. "Is Information Risk a Determinant of Asset Returns?," Journal of Finance, American Finance Association, vol. 57(5), pages 2185-2221, October.
    3. Kraus, Alan & Smith, Maxwell, 1996. "Heterogeneous Beliefs and the Effect of Replicatable Options on Asset Prices," The Review of Financial Studies, Society for Financial Studies, vol. 9(3), pages 723-756.
    4. Back, Kerry, 1993. "Asymmetric Information and Options," The Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 435-472.
    5. Kalok Chan & Y. Peter Chung & Wai-Ming Fong, 2002. "The Informational Role of Stock and Option Volume," The Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1049-1075.
    6. Lo, Andrew W & MacKinlay, A Craig, 1990. "When Are Contrarian Profits Due to Stock Market Overreaction?," The Review of Financial Studies, Society for Financial Studies, vol. 3(2), pages 175-205.
    7. Josef Lakonishok & Inmoo Lee & Allen M. Poteshman, 2004. "Investor Behavior in the Option Market," NBER Working Papers 10264, National Bureau of Economic Research, Inc.
    8. Brennan, Michael J & Cao, H Henry, 1996. "Information, Trade, and Derivative Securities," The Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 163-208.
    9. Vijh, Anand M, 1990. "Liquidity of the CBOE Equity Options," Journal of Finance, American Finance Association, vol. 45(4), pages 1157-1179, September.
    10. Charles Cao & Zhiwu Chen & John M. Griffin, 2005. "Informational Content of Option Volume Prior to Takeovers," The Journal of Business, University of Chicago Press, vol. 78(3), pages 1073-1109, May.
    11. Manaster, Steven & Rendleman, Richard J, Jr, 1982. "Option Prices as Predictors of Equilibrium Stock Prices," Journal of Finance, American Finance Association, vol. 37(4), pages 1043-1057, September.
    12. Easley, David & Kiefer, Nicholas M & O'Hara, Maureen, 1997. "One Day in the Life of a Very Common Stock," The Review of Financial Studies, Society for Financial Studies, vol. 10(3), pages 805-835.
    13. Lee, Charles M C & Ready, Mark J, 1991. "Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, vol. 46(2), pages 733-746, June.
    14. Franke, Gunter & Stapleton, Richard C. & Subrahmanyam, Marti G., 1998. "Who Buys and Who Sells Options: The Role of Options in an Economy with Background Risk," Journal of Economic Theory, Elsevier, vol. 82(1), pages 89-109, September.
    15. Tarun Chordia & Bhaskaran Swaminathan, 2000. "Trading Volume and Cross‐Autocorrelations in Stock Returns," Journal of Finance, American Finance Association, vol. 55(2), pages 913-935, April.
    16. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    17. David S. Bates, 2001. "The Market for Crash Risk," NBER Working Papers 8557, National Bureau of Economic Research, Inc.
    18. Simon Gervais & Ron Kaniel & Dan H. Mingelgrin, 2001. "The High‐Volume Return Premium," Journal of Finance, American Finance Association, vol. 56(3), pages 877-919, June.
    19. Grossman, Sanford J, 1988. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," The Journal of Business, University of Chicago Press, vol. 61(3), pages 275-298, July.
    20. Liu, Jun & Pan, Jun, 2003. "Dynamic derivative strategies," Journal of Financial Economics, Elsevier, vol. 69(3), pages 401-430, September.
    21. repec:bla:jfinan:v:59:y:2004:i:3:p:1235-1258 is not listed on IDEAS
    22. Kaushik I. Amin & Charles M. C. Lee, 1997. "Option Trading, Price Discovery, and Earnings News Dissemination," Contemporary Accounting Research, John Wiley & Sons, vol. 14(2), pages 153-192, June.
    23. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    24. repec:bla:jfinan:v:53:y:1998:i:2:p:431-465 is not listed on IDEAS
    25. Biais, Bruno & Hillion, Pierre, 1994. "Insider and Liquidity Trading in Stock and Options Markets," The Review of Financial Studies, Society for Financial Studies, vol. 7(4), pages 743-780.
    26. Mayhew, Stewart & Sarin, Atulya & Shastri, Kuldeep, 1995. "The Allocation of Informed Trading across Related Markets: An Analysis of the Impact of Changes in Equity-Option Margin Requirements," Journal of Finance, American Finance Association, vol. 50(5), pages 1635-1653, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Natividad Blasco & Pilar Corredor & Rafael Santamaría, 2010. "Does informed trading occur in the options market? Some revealing clues," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 50(3), pages 555-579, September.
    2. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    3. David Weinbaum & Andrew Fodor & Dmitriy Muravyev & Martijn Cremers, 2023. "Option Trading Activity, News Releases, and Stock Return Predictability," Management Science, INFORMS, vol. 69(8), pages 4810-4827, August.
    4. Hu, Jianfeng, 2014. "Does option trading convey stock price information?," Journal of Financial Economics, Elsevier, vol. 111(3), pages 625-645.
    5. Alejandro Bernales & Massimo Guidolin, 2013. "The Effects of Information Asymmetries on the Success of Stock Option Listings," Working Papers 484, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    6. Faff, Robert & Hillier, David, 2005. "Complete markets, informed trading and equity option introductions," Journal of Banking & Finance, Elsevier, vol. 29(6), pages 1359-1384, June.
    7. Atilgan, Yigit, 2014. "Volatility spreads and earnings announcement returns," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 205-215.
    8. Da‐Hea Kim, 2022. "Investment horizon and option market activity," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(5), pages 923-958, May.
    9. Alejandro Bernales & Thanos Verousis & Nikolaos Voukelatos & Mengyu Zhang, 2020. "What do we know about individual equity options?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(1), pages 67-91, January.
    10. Du, Brian & Fung, Scott, 2018. "Directional information effects of options trading: Evidence from the banking industry," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 56(C), pages 149-168.
    11. Muravyev, Dmitriy & Pearson, Neil D. & Paul Broussard, John, 2013. "Is there price discovery in equity options?," Journal of Financial Economics, Elsevier, vol. 107(2), pages 259-283.
    12. Gunther Capelle-Blancard & Séverine Vandelanoite, 2000. "Intraday relations between CAC 40 cash index and CAC 40 index options [Relations intrajournalières entre l'indice CAC 40 et les options sur indice. Quel est le marché préféré des investisseurs info," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-03727911, HAL.
    13. C. José García Martín & Begoña Herrero Piqueras & Ana María Ibáñez Escribano, 2016. "The informational role of thin options markets: Empirical evidence from the Spanish case," Estudios de Economia, University of Chile, Department of Economics, vol. 43(2 Year 20), pages 233-263, December.
    14. Rourke, Thomas, 2014. "The delta- and vega-related information content of near-the-money option market trading activity," Journal of Financial Markets, Elsevier, vol. 20(C), pages 175-193.
    15. Travis L. Johnson & Eric C. So, 2018. "A Simple Multimarket Measure of Information Asymmetry," Management Science, INFORMS, vol. 64(3), pages 1055-1080, March.
    16. Roll, Richard & Schwartz, Eduardo & Subrahmanyam, Avanidhar, 2014. "Trading activity in the equity market and its contingent claims: An empirical investigation," Journal of Empirical Finance, Elsevier, vol. 28(C), pages 13-35.
    17. Gunther Capelle-Blancard & Séverine Vandelanoite, 2002. "Relations intrajournalières entre l'indice CAC 40 et les options sur indice : Quel est le marché préféré des investisseurs informés ?," Annals of Economics and Statistics, GENES, issue 66, pages 143-177.
    18. A. Bernales, 2014. "The Effects of Information Asymmetries on the Ex-Post Success of Stock Option Listings," Working papers 495, Banque de France.
    19. Chang‐Mo Kang & Donghyun Kim & Junyong Kim & Geul Lee, 2022. "Informed trading of out‐of‐the‐money options and market efficiency," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 45(2), pages 247-279, June.
    20. Do, Viet & Truong, Cameron & Vu, Tram, 2022. "Options listings and loan contract terms: Information versus risk-shifting," Journal of Financial Markets, Elsevier, vol. 58(C).

    More about this item

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:10925. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/nberrus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.