The Information in Option Volume for Stock Prices

28 Pages Posted: 14 Jan 2003

See all articles by Allen M. Poteshman

Allen M. Poteshman

University of Illinois at Urbana-Champaign - Department of Finance

Jun Pan

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF); National Bureau of Economic Research (NBER); China Academy of Financial Research (CAFR)

Date Written: January 13, 2003

Abstract

We find strong evidence of information transmission from the options market to underlying stock prices. Taking advantage of a unique dataset from the Chicago Board Options Exchange, we construct put to call volume ratios for underlying stocks, using only volume initiated by buyers to open new positions. Performing daily cross-sectional analyses from 1990 to 2001, we find that buying stocks with low put/call ratios and selling stocks with high put/call ratios generates an expected return of 40 basis points per day and 1 percent per week. This result is present during each year of our sample period, and is not affected by the exclusion of earnings announcement windows. Moreover, the result is stronger for smaller stocks, indicating that the options market may be a more important avenue for information transmission for stocks with less efficient information flow. Our analysis also sheds light on the type of investor behind the informed option trading. Specifically, we find that option trading from customers of full service brokers provides the strongest predictability, while that from firm proprietary traders is not informative. Furthermore, our analysis shows that while public customers on average trade in the options market as contrarians -- buying fresh new puts on stocks that have done well and calls on stocks that have done poorly, firm proprietary traders exhibit the opposite behavior. Finally, in contrast to the equity options market, we do not find any evidence of informed trading in the index options market.

Keywords: options, information, volume, derivatives

JEL Classification: G12, G12, G14

Suggested Citation

Poteshman, Allen M. and Pan, Jun, The Information in Option Volume for Stock Prices (January 13, 2003). MIT Sloan Working Paper No. 4275-03. Available at SSRN: https://ssrn.com/abstract=368980 or http://dx.doi.org/10.2139/ssrn.368980

Allen M. Poteshman

University of Illinois at Urbana-Champaign - Department of Finance ( email )

340 Wohlers Hall
1206 South Sixth Street
Champaign, IL 61820
United States
217-265-0565 (Phone)
217-244-3102 (Fax)

HOME PAGE: http://www.business.uiuc.edu/poteshma

Jun Pan (Contact Author)

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

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