Option Trading: Information or Differences of Opinion?
56 Pages Posted: 28 Apr 2009 Last revised: 4 Apr 2011
Date Written: April 1, 2011
This paper investigates the motive of option trading. We show that option trading is mostly driven by differences of opinion, a finding different from the current literature that attempts to attribute option trading to information asymmetry. Our conclusion is based on three pieces of empirical evidence. First, option trading around earnings announcements is speculative in nature and mostly dominated by small, retail investors. Second, around earnings announcements, the pre-announcement abnormal turnovers of options seem to predict the post-announcement abnormal stock returns. However, once we control for the pre-announcement stock returns, the predictability completely disappears, implying that option traders simply take cues from the stock market and turn around to speculate in the options market. Third, cross-section and time-series regressions reveal that option trading is also significantly explained by differences of opinion at ordinary times. While informed trading is present in stocks, it is not detected in options.
Keywords: option trading, differences of opinion, informed trading, speculation, earnings announcements
JEL Classification: G18, G12, G14
Suggested Citation: Suggested Citation