Informed Trading in the Index Option Market
51 Pages Posted: 7 Jun 2017 Last revised: 17 Aug 2019
Date Written: June 5, 2017
We propose a structural vector autoregressive (VAR) model of informed trading in option markets to analyze whether investors use options to trade on private information about the underlying price and/or the underlying's volatility. We decompose option order flow into exposures to the underlying asset (through the option delta) and its volatility (through the option vega). Our proposed methodological framework facilitates meaningfully aggregation of option order flows for different strike prices and maturities, and increases statistical power to identify informed trading. A fitted model confirms that S&P500 option trades are indeed informative about changes in both the underlying and volatility.
Keywords: Options, informed trading, price impact
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