The Effects of Investor Sentiment on Speculative Trading and Prices of Stock and Index Options

52 Pages Posted: 24 Nov 2008 Last revised: 17 Mar 2009

See all articles by Michael L. Lemmon

Michael L. Lemmon

University of Utah - Department of Finance

Sophie Xiaoyan Ni

Hong Kong Baptist University (HKBU)

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2008

Abstract

We find that speculative demand for equity options is positively related to investor sentiment, while hedging demand is invariant to sentiment. Consistent with a demand based view of option pricing, we find that sentiment is related to time-series variation in the slope of the implied volatility smile of stock options, but has little impact on the prices of index options. The pricing impact is more pronounced in options with higher concentration of speculative trading, higher transactions costs, higher stock return volatility, and smaller stock size. Our results suggest that the correlated biases of noise traders affect the trading and prices of securities that are subject to speculation, but do not affect prices of securities in which demand is driven by hedging motives unrelated to sentiment.

Keywords: Derivatives, Index Options, Stock Options, Sentiments, Speculation

JEL Classification: G12, G13

Suggested Citation

Lemmon, Michael L. and Ni, Sophie Xiaoyan, The Effects of Investor Sentiment on Speculative Trading and Prices of Stock and Index Options (December 1, 2008). Available at SSRN: https://ssrn.com/abstract=1306237 or http://dx.doi.org/10.2139/ssrn.1306237

Michael L. Lemmon

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States
801-585-5210 (Phone)
801-581-7214 (Fax)

Sophie Xiaoyan Ni (Contact Author)

Hong Kong Baptist University (HKBU) ( email )

Department of Economics
Kowloon, Hong Kong
Hong Kong

HOME PAGE: http://sites.google.com/site/sophiexni/

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