Informed Trading of Out-of-the-Money Options and Market Efficiency

51 Pages Posted: 5 Jul 2016 Last revised: 15 Mar 2021

See all articles by Chang Mo Kang

Chang Mo Kang

Hanyang University - School of Business

Donghyun Kim

Chung-Ang University

Junyong Kim

University of Wisconsin - Milwaukee - Department of Finance

Geul Lee

Coinplug, Inc.

Date Written: March 14, 2021

Abstract

We examine stock return predictability of ``Out-of-The-Money (OTM) put-to-OTM call trading volume ratio" (OTMPC). Our numerical analysis predicts that, in the U.S. equity option market, informed investors hardly write OTM options because the leverage effect is not sufficient to compensate for transaction costs. OTMPC, thus, captures the informed investors' OTM put purchase volume relative to their OTM call purchase volume. After controlling for the existing empirical proxies for informed option trading, we find that OTMPC predicts future stock returns and corporate news. The return predictability offers implementable stock portfolio strategies. Our findings suggest that market inefficiency can emerge from uninformed investors' limited knowledge about how transaction costs influence the trading strategies of informed investors.

Keywords: Options, return predictability, trading volume

JEL Classification: G11, G12, G13, G14

Suggested Citation

Kang, Chang Mo and Kim, Donghyun and Kim, Junyong and Lee, Geul, Informed Trading of Out-of-the-Money Options and Market Efficiency (March 14, 2021). Available at SSRN: https://ssrn.com/abstract=2803724 or http://dx.doi.org/10.2139/ssrn.2803724

Chang Mo Kang

Hanyang University - School of Business ( email )

222, Wangsimni-ro
Seongdong-gu
Seoul
Korea

Donghyun Kim (Contact Author)

Chung-Ang University ( email )

221 Heuksuk-dong
Dongjak-gu
Seoul, 156-756
Korea, Republic of (South Korea)

Junyong Kim

University of Wisconsin - Milwaukee - Department of Finance ( email )

Milwaukee, WI 53201-0742
United States

Geul Lee

Coinplug, Inc. ( email )

11F, Office H, 20, Pangyoyeok-ro 146beon-gil,
Bundang-gu
Seongnam-si, Gyeonggi-do
Korea, Republic of (South Korea)

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