Positive Stock Information in Out-of-the-Money Option Prices

69 Pages Posted: 6 Jun 2017 Last revised: 7 Jun 2018

See all articles by Konstantinos Gkionis

Konstantinos Gkionis

Queen Mary University of London, School of Economics and Finance; University of Manchester - Alliance Manchester Business School

Alexandros Kostakis

University of Liverpool Management School; University of Manchester - Manchester Business School

George S. Skiadopoulos

Queen Mary, University of London, School of Economics and Finance; University of Piraeus

Przemyslaw Stan Stilger

University of Manchester - Manchester Business School

Date Written: May 30, 2018

Abstract

We examine whether the option market leads the stock market with respect to positive in addition to negative price discovery. We document that out-of-the-money (OTM) option prices, which determine the Risk-Neutral Skewness (RNS) of the underlying stock return's distribution, can embed positive information regarding the underlying stock. A long-only portfolio of stocks with the highest RNS values yields significant positive alpha in the post-ranking week during the period 1996-2014. This outperformance is mainly driven by stocks that are relatively underpriced but are also exposed to greater downside risk. These findings are consistent with a trading mechanism where investors choose to exploit perceived stock underpricing via OTM options due to their embedded leverage, rather than directly buying the underlying stock to avoid exposure to its potential downside. Due to the absence of severe limits-to-arbitrage for the long-side, the price correction signalled by RNS is very quick, typically overnight.

Keywords: Option-Implied Information, Price Discovery, Risk-Neutral Skewness, Stock Underpricing, Downside Risk

JEL Classification: G12, G13, G14

Suggested Citation

Gkionis, Konstantinos and Kostakis, Alexandros and Skiadopoulos, George and Stilger, Przemyslaw Stan, Positive Stock Information in Out-of-the-Money Option Prices (May 30, 2018). Available at SSRN: https://ssrn.com/abstract=2981107 or http://dx.doi.org/10.2139/ssrn.2981107

Konstantinos Gkionis

Queen Mary University of London, School of Economics and Finance ( email )

Mile End Road
London, E1 4NS
United Kingdom

HOME PAGE: http://econ.qmul.ac.uk/staff/konstantinosgkionis.html

University of Manchester - Alliance Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

Alexandros Kostakis (Contact Author)

University of Liverpool Management School ( email )

Chatham Building
Liverpool, L69 7ZH
United Kingdom

HOME PAGE: http://www.alexkostakis.com

University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

George Skiadopoulos

Queen Mary, University of London, School of Economics and Finance

Lincoln's Inn Fields
Mile End Rd.
London, E1 4NS
United Kingdom

University of Piraeus ( email )

80 Karaoli & Dimitriou Str.
18534 Piraeus, 185 34 -GR
Greece

HOME PAGE: http://web.xrh.unipi.gr/faculty/gskiadopoulos/

Przemyslaw Stan Stilger

University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

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