Where Do Informed Traders Trade? Trading Around News on Dow 30 Options

54 Pages Posted: 14 Mar 2011 Last revised: 18 Mar 2012

See all articles by Nitish Ranjan Sinha

Nitish Ranjan Sinha

Federal Reserve Board - Capital Markets Section

Wei Dong

Citigroup, Inc.

Date Written: March 12, 2011

Abstract

What is the role played by the option market in price discovery? We answer this question by examining the effect of news events on trading patterns and price discovery in the options and equity markets. Using intraday data on stocks and options and a dataset of over 70,000 firm-specific news events for Dow30 stocks, we find the volume of trading in the options increases almost seven times an hour before news, whereas the stock volume increases by 17%. The average information share of options for Dow30 stocks around news is almost 27%, in contrast to almost 10% in absence of news. For almost 5000 news events, there is no trading in the option market, whereas there is significant trading in the stock market. Since the trading in the option market spikes prior to news, the option market is probably a venue for informed trading, despite its illiquidity. The result suggests informed traders prefer options market despite its relative illiquidity. The short-sale ban moved more informed trading to the options market. The information share of the options market for financials increased by 31%, whereas no change occurred in non-financials. We find evidence consistent with Cao and Ou-Yang (2009), trading in the option markets stays at elevated level well after the event.

Keywords: Informed trading, Options, News, Volume, Market Microstructure, Information Share, Short selling, Financial Crisis

JEL Classification: G12, G14

Suggested Citation

Sinha, Nitish Ranjan and Dong, Wei, Where Do Informed Traders Trade? Trading Around News on Dow 30 Options (March 12, 2011). Midwest Finance Association 2012 Annual Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1785518 or http://dx.doi.org/10.2139/ssrn.1785518

Nitish Ranjan Sinha (Contact Author)

Federal Reserve Board - Capital Markets Section ( email )

20th & C. St., N.W.
Washington, DC 20551
United States

Wei Dong

Citigroup, Inc. ( email )

2 Court Square
10th Floor
Long Island City, NY 11120
United States
347-648-4633 (Phone)

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