The Information Content of Option Demand

60 Pages Posted: 16 Oct 2012 Last revised: 14 Sep 2015

Kerstin Kehrle

Independent

Tatjana Xenia Puhan

University of Mannheim - Department of International Finance; Swiss Life Asset Managers

Date Written: September 13, 2015

Abstract

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

Kehrle, Kerstin and Puhan, Tatjana Xenia, The Information Content of Option Demand (September 13, 2015). Swiss Finance Institute Research Paper No. 12-43. Available at SSRN: https://ssrn.com/abstract=2005763 or http://dx.doi.org/10.2139/ssrn.2005763

Kerstin Kehrle

Independent ( email )

Tatjana Xenia Puhan (Contact Author)

University of Mannheim - Department of International Finance ( email )

L9, 1-2
Mannheim, 68131
Germany

Swiss Life Asset Managers ( email )

General-Guisan-Quai 40
Zurich, 8022
Switzerland

HOME PAGE: http://www.swisslife-am.com/de/home.html

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