Is There Price Discovery in Equity Options?

Abstract

This paper presents direct evidence that option price quotes do not contain any information about future stock prices beyond what is already reflected in current stock prices. We use trade and quote data for 39 liquid U.S. stocks and ETFs and options on them, and focus on events when the two markets disagree about the stock price in the sense that the option-implied stock price obtained from the put-call parity relation is inconsistent with the actual stock price. In these disagreement events the options market adjusts bid and ask prices to eliminate the disagreement, while the stock market behaves normally, as if there were no disagreement. The disagreement events are typically precipitated by stock price moves, and often exhibit signed option volume providing pressure to eliminate the mispricing. These results are consistent with the hypothesis that option price quotes do not participate in the price discovery process for the underlying stock price, and stand in contrast to much of the existing literature.

Keywords: Price discovery, equity options, market microstructure, high frequency data, put-call parity

JEL Classification: G12, G13, G14