Does Option Trading Convey Stock Price Information?

50 Pages Posted: 24 Jul 2013 Last revised: 13 Nov 2013

See all articles by Jianfeng Hu

Jianfeng Hu

Singapore Management University - Lee Kong Chian School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: July 24, 2013

Abstract

After executing option orders, options market makers turn to the stock market to hedge away the underlying stock exposure. As a result, the stock exposure imbalance in option transactions translates into an imbalance in stock transactions. This paper decomposes the total stock order imbalance into an imbalance induced by option transactions and an imbalance independent of options. The analysis shows that the option-induced imbalance significantly predicts future stock returns in the cross section, but the imbalance independent of options only has a transitory price impact. Further investigation suggests that options order flow contains important information about the underlying stock value.

Keywords: Options, Order flow, Information asymmetry, Delta hedging, Price discovery

JEL Classification: G14, G12, G13

Suggested Citation

Hu, Jianfeng, Does Option Trading Convey Stock Price Information? (July 24, 2013). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2297763

Jianfeng Hu (Contact Author)

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
Singapore, 178899
Singapore
(+65) 68085477 (Phone)

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