43 Pages Posted: 7 Jun 2017 Last revised: 25 Jul 2017
Date Written: June 5, 2017
We estimate a structural model of informed trading in option markets. We decompose option order flow into exposures to the underlying asset (through the option delta) and its volatility (through the option vega). We then use these order flow exposures to predict changes in the underlying asset and volatility in a vector autoregressive (VAR) model. The model measures informed trading in the aggregate option market, as option order flows can be meaningfully combined across options with different strike prices and maturities. Further, the order flow aggregation increases statistical power, which is necessary to identify informed trading on the two components. The model also yields a novel price impact parameter of volatility speculation. Estimates using options on the S&P500 confirm that option trades are indeed informed about changes in both the underlying and volatility, although the magnitude of the former is substantially larger.
Keywords: Options, informed trading, price impact
Suggested Citation: Suggested Citation
Kaeck, Andreas and van Kervel, Vincent and Seeger, Norman, Informed Trading in the Index Option Market (June 5, 2017). TILEC Discussion Paper No. 2017-027. Available at SSRN: https://ssrn.com/abstract=2981332