Consolidating Information in Option Transactions
City University of New York, CUNY Baruch College, Zicklin School of Business; National University of Singapore (NUS) - Risk Management Institute
City University of New York (CUNY) - Department of Statistics and Computer Information Systems
City University of New York, CUNY Baruch College - Zicklin School of Business
January 13, 2011
Underlying each stock trades hundreds of options at different strike prices and maturities. The order flows from these option transactions reveal important information about the underlying stock price. How to aggregate the trade information of different option contracts underlying the same stock presents an interesting and important question for developing microstructure theories and price discovery mechanisms in the derivatives markets. This paper takes options on QQQQ, the Nasdaq 100 tracking stock, as an example and examines different order flow consolidation mechanisms in terms of their effectiveness in extracting information about the underlying stock price and volatility movements. The analysis leads us to propose an aggregation weighting scheme that depends both on the liquidity of each option contract and the contract's risk exposure, delta for stock price movement information and vega for volatility movement information. Based on this weighting scheme, we identify significantly positive correlations between the aggregate option order flows and the realized returns and volatilities. In particular, the delta buy pressure positively predicts the underlying return and the vega buy pressure positively predicts the change of volatilities.
Number of Pages in PDF File: 28working papers series
Date posted: January 16, 2011
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