Does Option Trading Convey Stock Price Information?

• Main Author: HU, Jianfeng
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2014
• Subjects: Options; Order flow; Information asymmetry; Delta hedging; Price discovery; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/3607; https://ink.library.smu.edu.sg/context/lkcsb_research/article/4606/viewcontent/DoesOptionTradingConveyStockPriceInformation.pdf
• Institution: Singapore Management University

After executing option orders, options market makers turn to the stock market to hedge away the underlying stock exposure. As a result, the stock exposure imbalance in option transactions translates into an imbalance in stock transactions. This paper decomposes the total stock order imbalance into an imbalance induced by option transactions and an imbalance independent of options. The analysis shows that the option-induced imbalance significantly predicts future stock returns in the cross section, but the imbalance independent of options only has a transitory price impact. Further investigation suggests that options order flow contains important information about the underlying stock value.