Call Options, Preferences for Lotteries, and the Stability of Underlying Stock Prices
Benjamin M. Blau
Utah State University - Huntsman School of Business
T. Boone Bowles
University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School
Ryan J. Whitby
Utah State University
July 2, 2013
Despite assumptions of mean-variance efficiency that underlie most asset pricing models, investors have shown a penchant for lottery-type stocks or stocks that exhibit skewness in returns. In this paper, we test whether the proportion of option trading volume made up from call options (i.e. the call ratio) is greater for stocks with return distributions that resemble lotteries. We find that call ratios are highest for stocks with lottery characteristics, suggesting that investors’ preferences for lottery-type stocks might be reflected in the level of call option volume. Perhaps, more importantly, we test whether these preferences affect future spot price volatility. Consistent with our expectation, we find that preferences for lotteries by call option traders directly affect future spot price volatility. To the extent that higher call ratios in lottery-type stocks represent speculative activity in the options market, these results are consistent with theory in Stein (1987), which posits that speculative trading activity in the derivatives market can lead to increased volatility.
Number of Pages in PDF File: 38
Keywords: options, lotteries, volatility
JEL Classification: G10, G14, G19
Date posted: July 3, 2013
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