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

Posted: 18 Mar 2010 Last revised: 9 May 2014

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: August 2011

Abstract

We find that the demand for stock option positions that increase exposure to the underlying is positively related to measures of investor sentiment and past market returns, while the demand for index options is invariant to these factors. These differences in trading patterns are reflected in differences in the composition of traders in the different types of options -- Options on stocks are actively traded by individual investors, while trades in index options are more often motivated by hedging demands of sophisticated investors. 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 a higher concentration of unsophisticated investors and in options with higher hedging costs. Our results provide new evidence factors not related to fundamentals affect price of securities actively traded by noise traders.

Keywords: Options, Volatility Smile, Sentiment, Speculation, Hedging

JEL Classification: G1

Suggested Citation

Lemmon, Michael L. and Ni, Sophie Xiaoyan, The Effects of Investor Sentiment on Speculative Trading and Prices of Stock and Index Options (August 2011). AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1572427 or http://dx.doi.org/10.2139/ssrn.1572427

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 )

Kowloon
Hong Kong

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

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