Option trading after the opening bell and intraday stock return predictability

Prior literature finds that information is reflected in option markets before stock markets, but no study has explored whether option volume soon after market open has predictive power for intraday stock returns. Using novel intraday signed option-to-stock volume data, we find that a composite option trading score (OTS) in the first 30 min of market open predicts stock returns during the rest of the trading day. Such return predictability is greater for smaller stocks, stocks with higher idiosyncratic volatility, and stocks with higher bid–ask spreads relative to their options’ bid–ask spreads. Moreover, OTS is a significantly stronger predictor of intraday stock returns after overnight earnings announcements. The evidence suggests that option trading in the 30 min after the opening bell has predictive power for intraday stock returns.     

A new methodology for studying intraday dynamics of Nikkei index futures using Markov chains

The empirical study of intraday patterns of stock trading volatilities and bid–ask spreads in the literature depends on assumptions of specific price generating process and may therefore not be robust to distributional assumptions. By creating discrete states that conform more naturally to the way prices are actually quoted in the derivatives and assets markets, we employ a new methodology of Markov chains for studying the intraday dynamics of derivative prices. We apply the method to study the intraday behavior of the Nikkei index futures prices, trading volumes, and spreads. We find some interesting results such as higher probabilities of transitions between larger volatilities at the opening and closing times. The volatility at lunch break is strikingly low. Contrary to most of the literature, the Nikkei intraday bid–ask spread does not show a U-shaped pattern. We offer some explanations.     

The impact of tick size on intraday stock price behavior: evidence from the Taiwan Stock Exchange

This research examines the impact of tick size on intraday stock price behavior for stocks listed on the Taiwan Stock Exchange over the 2-year period of 1998–1999. The sample involves the same 80 firms that trade under the tick size of (New Taiwan Dollars) NT$0.1 and NT$0.5, respectively. The sample firms display a U-shaped intraday pattern of bid–ask spread, volatility, autocorrelation, and trading volume. The empirical results indicate that a larger tick size is associated with a wider bid–ask spread, larger volatility, and more negative autocorrelation. Moreover, a larger tick size is associated with a higher percentage increase of bid–ask spread and volatility in the middle of the trading period. Finally, the effect of tick size on trading volume is insignificant.     

Stock market closure and intraday stock index futures market volatility: “contagion”, bid–ask bias or both?

Chang et al. [Journal of Business 68 (1) (1995) 61] examine the impact of the closure of the New York Stock Exchange (NYSE) on S&P500 stock index futures traded on the Chicago Mercantile Exchange. They document a decline in futures market volatility immediately after the close of the NYSE, and an increase 15 minutes later when the futures market closes. They attribute this to contagion–i.e. a decline in information transfer from equities to futures markets following the closure of the underlying market. This paper examines the impact of the extension of trading hours in Hang Seng Index futures traded on the Hong Kong Futures Exchange on the 20 November, 1998 to 15 minutes after the close of the underlying market (the Stock Exchange of Hong Kong). Using the unique natural experiment provided by this change, a pattern similar to US markets is documented for the Hang Seng Index Futures following the change in trading hours. This provides strong evidence that the intraday pattern in volatility is caused by market closure. Unlike US futures exchanges, price reporters on the floor of the Hong Kong Futures Exchange collect quote data in addition to trade data. This data facilitates a test of another plausible microstructure explanation for the observed behaviour–bid–ask bounce associated with trading activity. This paper provides evidence that bid–ask bounce also explains part of the observed intraday behaviour in price volatility.     

An empirical analysis of the supply of liquidity by locals in futures markets: Evidence from the Sydney Futures Exchange

Contrary to the received view of market makers in theoretical literature, this study provides direct evidence that locals on the Sydney Futures Exchange (SFE) do not trade exclusively as passive market participants. In fact, rather than act purely as market makers, locals as a group are almost as likely to demand as supply liquidity. Further, locals trading on the floor of the SFE are less likely to supply liquidity when bid–ask spreads, trading frequency and price volatility are high, as well as around information announcements. These findings are consistent with aggressive trading by locals on the basis of a short-lived information advantage. This study also documents considerable diversity in the propensity of locals to supply liquidity, finding that it is related to the quantity, frequency and average size of their trading activity.     

Time and dynamic volume–volatility relation

This paper examines volume and volatility dynamics by accounting for market activity measured by the time duration between two consecutive transactions. A time-consistent vector autoregressive (VAR) model is employed to test the dynamic relationship between return volatility and trades using intraday irregularly spaced transaction data. The model is used to identify the informed and uninformed components of return volatility and to estimate the speed of price adjustment to new information. It is found that volatility and volume are persistent and highly correlated with past volatility and volume. The time duration between trades has a negative effect on the volatility response to trades and correlation between trades. Consistent with microstructure theory, shorter time duration between trades implies higher probability of news arrival and higher volatility. Furthermore, bid–ask spreads are serially dependent and strongly affected by the informed trading and inventory costs.     

An empirical comparison of quoted and implied bid–ask spreads on futures contracts

This paper investigates the performance of a range of alternative measures of quoted and implied bid–ask spreads on futures contracts, using a complete record of all quotes and trades. Accurate calibration of bid–ask spreads is important for many applications, including tests of market efficiency and assessment of market microstructure models. The results show that the transactions based spread measures are biased estimates of quoted and effective spreads, which illustrates the need for considered implementation of such measures. Similar intraday behaviour is shown by the different measures, with wide spreads at the open and narrow spreads at the close under a competing market maker environment.     

The role of private information in return volatility,bid–ask spreads and price levels in the foreign exchange market

Trading volume and order flow have both been closely associated with informed trader activity in the market microstructure literature. Using theory that explains regular intraday patterns in trading data, we transform these two variables into proxies for private information and examine their relationships with bid–ask spreads and return volatility. We use a unique and unusually rich high-frequency intraday dataset from the world's largest financial market, namely, the electronic inter-dealer spot foreign exchange market. Our analysis takes account of institutional features peculiar to this order-driven market. Our empirical results strongly affirm our theoretical understanding of how these markets work. They also reveal how the structure of the inter-dealer spot FX market affects exchange rate volatility. Finally, we also explore how private information contributes to the evolution of prices.     

The impact of lunchtime closure on market behaviour: evidence from the Sydney Futures Exchange

This paper examines the impact of lunchtime closure on market behaviour. Between May and September, 1994 the Sydney Futures Exchange trialed lunchtime trading. The trial provides a unique natural laboratory experiment for examining the impact of lunchtime closure. The analysis reported in this paper documents abnormally high bid ask spreads, price volatility and trading volume on re‐opening of the market following lunchtime closure. These results confirm that closure has an impact on trading activity, and are consistent with the effects of strategic informed trading, a loss in price discovery and/or trading associated with risk transfer. An abnormal increase in trading volume prior to lunchtime closure is also documented, providing unambiguous evidence of trading activity motivated by risk transfer. Overall these results imply that lunchtime closure disrupts trading activity and reduces market quality by imposing additional costs on market participants.     

The impact of lunchtime closure on market behaviour: evidence from the Sydney Futures Exchange

This paper examines the impact of lunchtime closure on market behaviour. Between May and September, 1994 the Sydney Futures Exchange trialed lunchtime trading. The trial provides a unique natural laboratory experiment for examining the impact of lunchtime closure. The analysis reported in this paper documents abnormally high bid ask spreads, price volatility and trading volume on re‐opening of the market following lunchtime closure. These results confirm that closure has an impact on trading activity, and are consistent with the effects of strategic informed trading, a loss in price discovery and/or trading associated with risk transfer. An abnormal increase in trading volume prior to lunchtime closure is also documented, providing unambiguous evidence of trading activity motivated by risk transfer. Overall these results imply that lunchtime closure disrupts trading activity and reduces market quality by imposing additional costs on market participants.     

Stock splits in a retail dominant order driven market

This paper uses intraday and daily data from the Stock Exchange of Thailand (SET) between 2002 and 2004 to provide evidence that firms use stock splits to bring their stock prices down to a preferred trading range of their clientele base. Stock splits reduce bid–ask spreads and intraday and daily price impact while increasing depths supplied by retail investors who account for 60–70% of trading on the SET. Firms that choose a high split factor experience greater improvement in liquidity. The study finds no evidence that split announcements are used to signal post-split earnings performance.     

Options and earnings announcements: an empirical study of volatility, trading volume, open interest and liquidity

In this paper we study the impact of earnings announcements on implied volatility, trading volume, open interest and spreads in the stock options market. We find that implied volatility increases before announcement days and drops afterwards. Also option trading volume is higher around announcement days. During the days before the announcement open interest tends to increase, while it returns to regular levels afterwards. Changes in the quoted spread largely respond to higher trading volume and changes in implied volatility. The effective spread increases on the event day and on the first two days following the earnings announcement.     

The impact of trading halts on liquidity and price volatility: Evidence from the Australian Stock Exchange

This study examines market behaviour around trading halts associated with information releases on the Australian Stock Exchange, which operates an open electronic limit order book. Using the Lee, Ready and Seguin (1994) pseudo-halt methodology, we find trading halts increase both volume and price volatility. Trading halts also increase bid-ask spreads and reduce market depth at the best-quotes in the immediate post-halt period. The results of this study imply that trading halts impair rather than improve market quality in markets that operate open electronic limit order books.     

Intraday patterns in London listed Exchange Traded Funds

In this paper we examine the intraday trading patterns of Exchange Traded Funds (ETFs) listed on the London Stock Exchange. ETFs have been shown to be characterised by much lower bid–ask spread costs and by lower levels of information asymmetry than individual securities. One possible explanation for intraday trading patterns is that concentration of trading arises at the start of the trading day because informed traders have private information that quickly diminishes in value as trading progresses. Since ETFs have lower trading costs and lower levels of information asymmetry we would expect these securities to display less pronounced intraday patterns than individual securities. We fail to find that ETFs are characterised by concentrated trading bouts during the day and therefore find support for the argument that information asymmetry is the cause of intraday volume patterns in stock markets. We find that ETF bid–ask spreads and volatility are elevated at the open but not at the close. This lends support to the “accumulation of information” explanation that sees high spreads and volatility at the open as a consequence of information accumulating during a market closure and impacting on the market when it next opens.     

Intraday Price Change and Trading Volume Relations in the Stock and Stock Option Markets

This study investigates intraday relations between price changes and trading volume of options and stocks for a sample of firms whose options traded on the CBOE during the first quarter of 1986. After purging the price change series of the effects of bid/ask spreads, multivariate time-series analysis is used to estimate the lead/lag relation between the price changes in the option and stock markets. The results indicate that price changes in the stock market lead the option market by as much as fifteen minutes. The analysis of trading volume indicates that the stock market lead may be even longer.     

Effect of the ban on short selling on market prices and volatility

We examine the effects of the short‐selling ban, imposed by Australian regulators in the wake of the global financial crisis, on the trading of financial stocks. Our findings argue against commonly stated reasons for imposing short‐sale bans. We find no evidence that short‐sale restrictions provide support for stock prices or that they reduce volatility. Moreover, stocks subject to the short‐selling ban suffered a severe degradation in market quality. Controlling for the adverse effects of the financial crisis on markets, we show that short‐selling restrictions increase intraday volatility, reduce trading activity and increase bid–ask spreads.     

Discount rate changes,stock market returns,volatility, and trading volume: Evidence from intraday data and implications for market efficiency

We examine the effect of discount rate changes on stock market returns, volatility, and trading volume using intraday data. Equity returns generally respond negatively and significantly to the unexpected announcements; however, the effect of expected changes on equity returns is insignificant. Furthermore, our results indicate that equity prices respond to announcements within the trading period/hour after the information release. An indication of a return reversal is too small to cover the full transaction costs. Unexpected discount rate changes also contribute to higher market volatility although the volatility is short-lived. Similarly, unexpected changes in discount rates induce larger trading volume while expected changes do not. Abnormal trading volume occurs only in period t. Our results also support the notion that unexpected changes in the discount rates impact market returns irrespective of the Federal Reserve operating procedures.     

Relative performance of bid–ask spread estimators: Futures market evidence

The issue of transaction costs is the mainstay of the equity market microstructure. Research in the microstructure of futures markets has lagged behind. A primary reason is that futures exchanges in the U.S. do not record bid–ask quotes, requiring these costs to be imputed from transaction price data. A reliable estimator of bid–ask spreads would significantly enhance microstructure research in futures markets. Unique intraday data from the Sydney Futures Exchange (SFE) that include both transaction prices and bid–ask spreads allow us to compare bid–ask spread estimation techniques proposed in the literature against the benchmark of actual spreads in a futures market, and thus identify the best-performing estimator. To maximize relevance, we impose all the constraints that apply in U.S. futures data to perform our estimations. We find that the four bid–ask spread estimators considered significantly underestimate the actual spreads. However, simple moments-based estimators perform better in predicting spreads.     

Did crisis alter trading of two major oil futures markets?

The paper analyzes how traders in two major oil futures markets: New York Mercantile Exchange (NYMEX) and Intercontinental Exchange, reacted to the 2008 financial crisis, particularly whether they shifted their trading pattern and whether the relative information role of the two markets changed. Using trade-by-trade data, the paper analyzes several trading characteristics including trading volume, trade size, volatility, bid–ask spread, and relative information share. On average, NYMEX is characterized by greater volume, trade size and slightly greater spread. Before the crisis, NYMEX leads the process of price discovery, and volatility and trade size are significant factors explaining this leadership. However, following the financial crisis of 2008, the leadership role of NYMEX declines and trade size and volatility are no longer significant factors. Contrary to results of most equity market research, bid–ask spread is not a significant factor in information share and causality tests indicate that causality runs from spread to information share before the crisis but the opposite holds during the crisis period.     

Liquidity of emerging markets

Emerging markets are characterized by volatile, but substantial returns that can easily exceed 75% per annum. Balancing these lofty returns are liquidity costs that, using the bid–ask spread as a basis, range from 1% for the Taiwanese market to over 47% for the Russian market. However, the paucity of bid–ask spread information across countries and time requires the use of liquidity estimates in emerging markets even though little is known about the efficacy of these estimates in measuring bid–ask spread costs. Using firm-level quoted bid–ask spreads as a basis, I find that price-based liquidity measures of Lesmond et al. [Review of Financial Studies 12 (1999) 1113] and Roll [Journal of Finance 39 (1984) 1127] perform better at representing cross-country liquidity effects than do volume based liquidity measures. Within-country liquidity is best measured with the liquidity estimates of either Lesmond, Ogden, and Trzcinka or, to a lesser extent, Amihud (2002). Examining the impact of legal origin and political institutions on liquidity levels shows that countries with weak political and legal institutions have significantly higher liquidity costs than do countries with strong political and legal systems, even to the exclusion of legal origin or insider trading enforcement. Higher incremental political risk is associated with a 10 basis point increase in transaction costs, using the Lesmond, Ogden, and Trzcinka estimate, or a 1.9% increase in price impact costs, using the Amihud estimate.