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The effect of option transaction costs on informed trading in the options market around earnings announcements |
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| Authors: | Suresh Govindaraj Yubin Li Chen Zhao |
| Institution: | 1. Rutgers Business School-Newark and New Brunswick, Rutgers, the State University of New Jersey, Newark, NJ, United States;2. School of Economics and Management, Harbin Institute of Technology, Shenzhen, China;3. School of Accounting, Southwestern University of Finance and Economics, Chengdu, China |
| Abstract: | We investigate the effect of option market transaction costs (a form of market imperfection) on the ability of option implied volatility-based measures to predict future stock returns and volatility around quarterly earnings announcements. We find that the predictability is significantly stronger for firms with lower option relative bid-ask spreads. The effect is more pronounced around positive rather than negative earnings news. We find no significant effect of option transaction costs around randomly chosen dates when there is no clustering of major information events. Trading strategies based on option market predictors and transaction costs earn monthly abnormal returns of 1.39% to 1.91%. |
| Keywords: | Earnings Announcements Informed Trading Option Transaction Costs |