Decomposing the Options Order Imbalance: Arbitrage and Informed Trades

Abstract

This study suggests a novel approach for decomposing an options order imbalance based on trading motives using put-call parity. The options order imbalance is separated into two components: one that contains arbitrage trading and one that does not. Intuitively, the proportion of the former component increases when arbitrage opportunities between financial markets increase and decreases when the markets are favorable for informed trading. We find that only foreign (domestic) institutions trade to exploit arbitrage opportunities between options and futures (stock index) markets, However, these patterns disappear after the enactment of market reform. Domestic individuals do not participate in arbitrage trading regardless of the regime. Finally, intraday analyses show that arbitrageurs are generally reluctant to trade near market opening and closing.

Keywords: Arbitrage trading, Informed trading, Options, Order imbalance, put-call parity