Synthetic Long Stock and Option Trading: Evidence from Stock Splits

Abstract

Current literature considers information and opinion dispersion the two primary driving forces of option trading. We theoretically and empirically investigate whether synthetic long stock drives option trading. Our synthetic long stock model predicts that stock price is positively associated with option trading. Moreover, stock (option) trading cost positively (negatively) relates to this association. We design a stock split based event study to test these predictions. We find that option trading significantly declines after stock splits due to the stock price decline caused by the stock splits. Further, the decline in option trading after stock splits positively depends on stock split factor and stock trading cost but negatively depends on option trading cost. These findings support our model and imply that capital-constrained traders’ use of synthetic long stocks contributes to option trading.

Keywords: Option trading, Synthetic long stock, Stock split

JEL Classification: G11, G12