Order Flow and Expected Option Returns

Muravyev, Dmitriy

doi:10.2139/ssrn.1963865

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Order Flow and Expected Option Returns

Journal of Finance, Forthcoming

57 Pages Posted: 23 Nov 2011 Last revised: 5 Nov 2015

See all articles by Dmitriy Muravyev

Dmitriy Muravyev

University of Illinois at Urbana-Champaign - Department of Finance; Canadian Derivatives Institute

Date Written: January 20, 2015

Abstract

I show that the inventory risk faced by market-makers has a first-order effect on option prices. I introduce a simple approach that decomposes the price impact of trades into inventory risk and asymmetric information components. While both components are large for option trades, the inventory risk component is larger. Using the full panel of daily option returns, I find that option order imbalances attributable to inventory risk have five times larger impact on option prices than previously thought. Finally, I find that past order imbalances have greater predictive power than any other commonly used predictor of option returns.

Keywords: Option returns, order imbalance, inventory, equity options

JEL Classification: G14, G10, G12, G13

Suggested Citation: Suggested Citation

Muravyev, Dmitriy, Order Flow and Expected Option Returns (January 20, 2015). Journal of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1963865 or http://dx.doi.org/10.2139/ssrn.1963865