Index Option Trading Activity and Market Returns
67 Pages Posted: 22 Jun 2016 Last revised: 20 May 2018
Date Written: May 17, 2018
Do order flows in index derivatives play an informational role? Index put order flow on the International Securities Exchange positively and robustly predicts S&P 500 index returns. This result obtains symmetrically for net put buying and selling. We explore rationales for our findings, which include panic driven put buying during market declines, demand for crash insurance, and the notion that market makers trade on information in options markets. The last explanation is the one most consistent with our analysis. Supporting this explanation, we find that the predictive ability of put order flow increases when the differential between bid-to-bid and ask-to-ask returns is higher.
Keywords: index options, order flow, information, market efficiency
JEL Classification: G12, G14
Suggested Citation: Suggested Citation