Volatility Information in Index Option Demand
37 Pages Posted: 26 Jun 2013 Last revised: 26 Jul 2014
Date Written: July 26, 2014
This paper provides evidence that demand for equity index options has predictive power for future volatility beyond current, lagged volatility and the VIX in widely available, low-frequency data. The predictive power increases prior to macroeconomic announcements and exhibits a positive relation with investor uncertainty about macroeconomic news. Straddle positions that trade on the volatility informed index option demand yield annualized Sharpe Ratios that are up to twice as large as the Sharpe Ratios on a long index investment. Sharpe Ratios increase with the amount of volatility informed trading in the options market. In times of high volatility, the demand for straddle positions contains significantly more information and has an impact on option liquidity levels.
Keywords: Option Demand, Open Interest, Volatility Information, Macroeconomic Announcements, Index Options
JEL Classification: D82, G10, G12, G14
Suggested Citation: Suggested Citation