Is There Price Discovery in Equity Options?

Abstract

We use “tick-by-tick” quote data for 39 liquid U.S. stocks 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. Option market quotes adjust to eliminate the disagreement, while the stock market quotes behave normally, as if there were no disagreement. The disagreement events are typically precipitated by stock price movements, and display signed option volume in the direction that tends to eliminate the disagreements. These results show that option price quotes do not contain economically significant information about future stock prices beyond what is already reflected in current stock prices, i.e. no economically significant “price discovery” occurs in the option market. We also find no option market price discovery using a much larger sample of disagreement events based on a weaker definition of a disagreement, which verifies that the findings for the primary sample are not due to unusual or unrepresentative market behavior during the put-call parity violations.

Keywords: Price Discovery, Equity Options, Market Microstructure, High Frequency Data, Put-Call Parity

JEL Classification: G14