Decomposing Informed Trading in Equity Options

Abstract

We develop a multi-asset model to decompose informed trading into the components concerning the underlying stock value and the volatility in equity options. We isolate the stock value and volatility components by characterizing their distinct intraday price responses in contracts with different option deltas and vegas, respectively. The stock value (volatility) component represents on average 40.5% (19.0%) of the option spread. In daily empirical applications, we also show that informed trading components anticipate a 'Volmageddon' high-volatility event, and an increase in straddle trades is associated with a reduction (growth) in the relative contribution of the stock value (volatility) informed trading.

Keywords: Asymmetric information, volatility information, underlying stock value information, equity option markets, option order flow

JEL Classification: D82, D84, G14, G13