High-frequency Trading in the Stock Market and the Costs of Option Market Making

42 Pages Posted: 18 Feb 2021 Last revised: 28 Mar 2023

See all articles by Mahendrarajah Nimalendran

Mahendrarajah Nimalendran

University of Florida - Department of Finance, Insurance and Real Estate

Khaladdin Rzayev

University of Edinburgh; Koc University; Systemic Risk Centre - LSE

Satchit Sagade

Nasdaq, Inc.; Leibniz Institute for Financial Research SAFE

Date Written: January 1, 2020

Abstract

We investigate the impact of high-frequency trading (HFT) in equity markets on options market liquidity. We find that an increase in volume originating from aggressive trading strategies employed by HFTs in the stock market is associated with higher bid-ask spreads in the options market. This relationship is largely driven by options market makers’ quotes being exposed to sniping risk by HFTs attempting to profit from put-call parity violations. In addition, we show that this relationship is causal by using the introduction of flash orders by NASDAQ as an exogenous shock to HFT in the stock market.

Keywords: market microstructure; high-frequency trading; options market-making; hedging; liquidity *

JEL Classification: G14, G18

Suggested Citation

Nimalendran, Mahendrarajah and Rzayev, Khaladdin and Sagade, Satchit, High-frequency Trading in the Stock Market and the Costs of Option Market Making (January 1, 2020). Available at SSRN: https://ssrn.com/abstract=3776590 or http://dx.doi.org/10.2139/ssrn.3776590

Mahendrarajah Nimalendran

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States

Khaladdin Rzayev (Contact Author)

University of Edinburgh ( email )

Old College
South Bridge
Edinburgh, Scotland EH8 9JY
United Kingdom

Koc University ( email )

Rumelifeneri Yolu
34450 Sar?yer
Istanbul, 34450
Turkey

Systemic Risk Centre - LSE ( email )

Houghton St, London WC2A 2AE, United Kingdom

Satchit Sagade

Nasdaq, Inc. ( email )

Tullvaktsvägen 15
Stockholm, Stockholm 105 78
Sweden
+4684057967 (Phone)

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany
+49 176 72222 049 (Phone)

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