Stock Illiquidity and Option Returns

49 Pages Posted: 7 Dec 2015 Last revised: 5 Dec 2020

See all articles by Stefan Kanne

Stefan Kanne

Karlsruhe Institute of Technology (KIT) - Institute for Finance

Olaf Korn

University of Goettingen (Gottingen)

Marliese Uhrig-Homburg

Karlsruhe Institute of Technology (KIT) - Institute for Finance

Date Written: December 4, 2020

Abstract

We provide evidence of a strong effect of the underlying stock’s illiquidity on option returns. By conditioning on end user demand, we find that the corresponding illiquidity premiums are negative and decrease in stock illiquidity if there is net buying pressure, while premiums are positive and tend to increase otherwise. Our results cannot be explained by common risk factors and cross-sectional differences in stock volatility or option spreads and are robust to different illiquidity measures and data periods. We explain the observed pattern through an intermediary hedging cost channel. The magnitudes of our illiquidity premiums are in line with reasonable transaction cost assumptions.

Keywords: Illiquidity, equity options, option returns, hedging costs

JEL Classification: G12, G13

Suggested Citation

Kanne, Stefan and Korn, Olaf and Uhrig-Homburg, Marliese, Stock Illiquidity and Option Returns (December 4, 2020). Available at SSRN: https://ssrn.com/abstract=2699529 or http://dx.doi.org/10.2139/ssrn.2699529

Stefan Kanne (Contact Author)

Karlsruhe Institute of Technology (KIT) - Institute for Finance ( email )

D-76128 Karlsruhe
Karlsruhe
Germany

Olaf Korn

University of Goettingen (Gottingen) ( email )

Platz der Gottinger Sieben 3
Gottingen, D-37073
Germany
++49 551 39 7265 (Phone)
++49 551 39 7665 (Fax)

Marliese Uhrig-Homburg

Karlsruhe Institute of Technology (KIT) - Institute for Finance ( email )

P.O. Box 6980
D-76049 Karlsruhe, DE
Germany
+49 721 6084 8183 (Phone)
+49 721 6084 8190 (Fax)

HOME PAGE: http://derivate.fbv.kit.edu/english/index.php

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