Price Discovery in Stock and Options Markets

Abstract

Using new empirical measures of information leadership, we find that the role of options in price discovery is up to five times larger than previously thought. Approximately one-quarter of new information is reflected in options prices before being transmitted to stock prices, with options playing a more important role in price discovery around information events. Using unique data on prosecuted insider trading, we find that insider traders often choose to trade in options, attracted by their leverage, and when they do the options share of price discovery is higher. Our results help interpret conflicting findings in the existing literature.

Keywords: price discovery, stock, option, information share, insider trading

JEL Classification: G14