The Information Content of Option Demand
60 Pages Posted: 16 Oct 2012 Last revised: 14 Sep 2015
Date Written: September 13, 2015
This paper combines the concept of market sidedness with excess option demand (changes in open interest) to solve the empirical challenge of separating directional from uninformed trading motives in widely available, unsigned options data. Our measure of options market sidedness persistently predicts the sign and strength of stock returns.
Trading strategies conditional on the measure are highly profitable. For instance, when the measure indicates positive (negative) information, out-of-the-money calls (puts) generate returns of 27% (32%) over roughly four weeks. Risk-adjusted returns of a long-short equity strategy yield more than 2%. An increase in directionally informed demand predicts a decrease in option liquidity and increases in pricing inefficiency.
Keywords: Option Demand, Market Sidedness, Open Interest, Liquidity, Market Microstructure
JEL Classification: D82, G10, G12, G14
Suggested Citation: Suggested Citation