Does Option Trading Have a Pervasive Impact on Underlying Stock Prices?

Abstract

The question of whether and to what extent option trading impacts underlying stock prices has been a focus of interest since options began exchange-based trading in 1973. Recent research presents evidence of an informational channel through which option trading impacts stock prices by showing that option market makers’ delta hedge trades to hedge new options positions cause the information reflected in option trading to be impounded into underlying equity prices. This paper provides evidence of a non-informational channel by showing that option market maker hedge rebalancing impacts both stock return volatility and the probability of large stock price moves.

Keywords: option trading, option open interest, delta-hedging, pinning, stock return volatility

JEL Classification: G12, G13, G14, G23