Volume,volatility and information linkages in the stock and option markets

This paper examines the relationship between option trading activity and stock market volatility. Although the option market is uniquely suited for trading on volatility information, there is little analysis on how trading activity in this market is linked to stock price volatility. The bulk of the discussion tends to focus on whether trading activity in the stock market is informative about stock volatility. To analyze the information in option trading activity for stock market volatility, a sample of 15 stocks with the highest option trading volume is selected. For each stock, it is noted that the trading activities in the put and call option markets have significant explanatory power for stock market volatility. In addition, the results indicate that the call option trading activity has a stronger impact on stock volatility compared with that of the put options. Our results demonstrate that information and sentiment in the option market is useful for the estimation of stock market volatility. Also, the significance of the effects of option trading activity on stock price volatility is observed to be comparable to that of stock market trading activity. Furthermore, the persistence and asymmetric effects in the volatility of some stocks tend to disappear once option trading activity is taken into account.     

Who benefits in a crisis? Evidence from hedge fund stock and option holdings

We use a unique data set of hedge fund long equity and equity option positions to investigate a significant lockup-related premium earned during the tech bubble (1999–2001) and financial crisis (2007–2009). Net fund flows are significantly greater among lockup funds during crisis and noncrisis periods. Managers of hedge funds with locked-up capital trade opportunistically against flow-motivated trades of non-lockup managers, consistent with a hypothesis of rent extraction in providing crisis era liquidity. The success of this opportunistic trading is concentrated during periods of high borrowing costs, in less liquid stock markets, and is enhanced by hedging in the equity option market.     

Transaction costs in an illiquid order‐driven market

Transaction costs in many international equity markets are much larger than those in the USA. This raises questions such as what trade size these reported trading costs relate to and whether investors can reduce trading costs by timing their trades. We show, using data from the order‐driven New Zealand market, that transaction costs are frequently lower for larger trades, particularly in small stocks, and investors are able to reduce costs by timing their transactions. While investors who require immediate execution incur transaction costs that are much higher than reported average costs, patient investors can trade at much better rates.     

The intraday behaviors and relationships with its underlying assets: evidence on option market in Taiwan

In this paper, we use daily data to investigate the information asymmetric effects and the relationships between the trading volume of options and their underlying spot trading volume. Our results reveal that options with higher liquidity are near-the-money and expiration periods with 2 to 4 weeks have higher trading activity. We classify them into two parts with the ARIMA model: the expected trading activity impact and the unexpected trading activity impact. Using the bivariate generalized autoregressive conditional heteroscedasticity (GARCH) model, we investigate the trading activity effect and information asymmetric effect. In conclusion, the trading volume volatility of the spot and options markets move together, and a greater expected and unexpected trading volume volatility of the spot (options) market is associated with greater volatility in the options (spot) market. However, both markets generate higher trading volume volatility when people expect such an impact rather than when they do not. We also find that there are feedback effects within these two markets. Furthermore, when the spot (options) market has negative innovations, it generates a greater impact on the options (spot) market than do positive innovations. Finally, the conditional correlation coefficient between the spot and the option markets changes over time based on the bivariate GARCH model.     

Impact of stock market trading on currency market volatility spillovers

This research aims to detect the volatility linkages among various currencies during operating and non-operating hours of three major stock markets (Tokyo, London and New York) by employing bivariate VAR-BEKK-GARCH model in selected currency pairs. In particular, the aim is to analyze whether the major stock markets have a differential impact on volatility linkages in currency markets. The results indicate that volatility linkages in intraday are far stronger then in daily results. One remarkable result is that rather than major currencies, some minor and exotic currencies play a leading role in volatility transmission during trading hours of major stock markets.     

Informed Trading Around Earnings Announcements: Another Look

This study is an empirical test of the Easley, O'Hara, and Srinivas (1998) multimarket sequential trade model of stock and option markets. We employ two approaches to determine the information content of signed stock and option trades executed around quarterly earnings announcements. The first approach expands the vector autoregression (VAR) technique of Hasbrouck (1991a) to include signed option trade volumes and inter‐trade durations. Estimates from the VAR models provide insight into whether both equity and option trades are viewed as informative by the equity specialist. The second approach focuses on the information content of the earnings releases to determine whether signed equity and option trades executed prior to the announcements are informed. Results indicate that although informed traders prefer to transact in both markets around earnings announcements, option market transactions contain no incremental information.     

Institutional stock trading on loan market information

One of the most important developments in the corporate loan market over the past decade has been the growing participation of institutional investors. As lenders, institutional investors routinely receive private information about borrowers. However, most of these investors also trade in public securities. This leads to a controversial question: Do institutional investors use private information acquired in the loan market to trade in public securities? This paper examines the stock trading of institutional investors whose portfolios also hold loans. Using the Securities and Exchange Commission filings of loan amendments, we identify institutional investors with access to private information disclosed during loan amendments. We then look at abnormal returns on subsequent stock trades. We find that institutional participants in loan renegotiations subsequently trade in the stock of the same company and outperform trades by other managers and trades in other stocks by approximately 5.4% in annualized terms.     

Sentiment and stock market connectedness: Evidence from the U.S. – China trade war

We assess the impact of monthly and daily investor sentiment on stock market return and volatility connectedness during the U.S.-China trade war period. Our analyses focus on the connectedness between the two economies and their major trading partners. We also investigate the asymmetric impact of sentiment on volatility connectedness by exploring the upside and downside markets separately. We consistently document a negative relationship between investor sentiment and stock market connectedness for both return and volatility. We further confirm that investor sentiment exerts a larger impact on volatility connectedness in the downside market compared to the upside market.     

Stock and option market divergence in the presence of noisy information

We examine market behavior of the stock and option markets upon the arrival of noisy information in the form of CNBC’s Mad Money recommendations. If stock and option markets are not equally efficient, they should respond differently to noisy information, with the less efficient market more susceptible to noise. We find that the stock market is less efficient than the option market. The abnormal difference between option-implied and actual stock returns is negative and significant upon exposure to noisy information. This difference may yield an economically significant monthly trading profit of up to 5%. We conclude that the stock market is more susceptible to noisy information than the option market and is therefore less efficient.     

Which trades move prices in emerging markets?: Evidence from China's stock market

This paper extends Barclay and Warner's [Barclay, M.J. and J.B. Warner (1993), ‘Stealth trading and volatility: which trades move prices?’, Journal of Financial Economics, vol. 34, pp. 281–306.] original work on stealth trading by analysing which trades move price for the emerging Chinese stock market. A large block trade/manipulation hypothesis is proposed in addition to the stealth and public information hypotheses examined by Barclay and Warner. Using high-frequency data the results show that while medium and large-size trades are associated with disproportionately large, overall, cumulative stock price changes, it is the large-size trades (in terms of the number of transactions) which have the largest effect on cumulative price increases. Thus, while there is some support for stealth trading in the Chinese market, there are other effects in operation such as large block trades/price manipulation.     

Daily institutional trades and stock price volatility in a retail investor dominated emerging market

We examine the short-run dynamic relation between daily institutional trading and stock price volatility in a retail investor-dominated emerging market. We find a significantly negative relation between volatility and institutional net trading that is mainly due to the unexpected institutional trading. The price volatility–institutional trade relation differs for institutional buys and institutional sells, and for small and large stocks. Institutional investors herd-trade in large stocks, but do not systematically engage in positive-feedback trading. We argue that the net impact of informational and noninformational institutional trades determines the relation between volatility and institutional trading, and that the relation is negative when informational trading by institutions prevails.     

Stock price decreases prior to executive stock option grants

This study examines abnormal stock price changes prior to executive stock option grants. Executives have the incentive and opportunity to manage the timing of their communications of inside information to the market during the period just prior to the date of their stock-option grant so as to reduce the exercise price of their options. Executives benefit from temporary stock price decreases before the grant date and by stock price increases after the grant date. Executive stock option grants create a unique opportunity for insiders to profit by manipulating the timing of information flowing to the market without engaging in insider trading. Using data on 783 stock-option grants to chief executive officers, we find a statistically significant abnormal decrease in stock prices during the 10-day period immediately preceding the grant date.     

Liquidity commonality and high frequency trading: Evidence from the French stock market

High frequency trading (HFT) depends on sophisticated algorithms to closely monitor price changes across securities. Theory predicts this technological advantage should translate into market-wide liquidity co-variation, by transmitting information-based liquidity shocks. Using a dataset of orders and trades from the French stock market, we investigate whether HFT algorithms constitute a source of systematic liquidity risk. We demonstrate that, across securities, the liquidity offered by high frequency traders is significantly less diverse than that of traditional traders; this finding is in line with the cross-asset learning hypothesis. The excessive co-movement in liquidity is also partly explained by common market making rules. In periods of increased market stress, we find HFT, designated market making, and order size to be important sources of liquidity commonality. Our results have policy implications for market regulators in Paris, suggesting the inclusion of maximum spread-limit rules in market making contracts will reduce the possibility of liquidity drying up when markets are in turmoil.     

Risk sharing in a financial market with endogenous option prices

This article investigates a financial market in which investors may trade in risk-free bonds, stock and put options written on the stock. In each period, stock and option prices are simultaneously determined by market clearing. While the introduction of put options will decrease the systematic risk in the financial market, it will increase the price of risk. Investors with mean-variance preferences will generally hold portfolios containing the primary asset and the put option and may use the option to increase the risk in their wealth position in exchange for higher returns. Aggregate wealth is unaffected by an option market when there are no spillover effects on stock prices, and it is shown that short selling of options will increase the volatility of individual wealth positions. Investors with erroneous beliefs may on average be better off not trading in put options.     

Volatility effects of institutional trading in foreign stocks

This paper examines the impact of institutional trades on volatility in international stocks across 43 countries. There is a temporary volatility spike during the trade execution period, merely reflecting the price impact costs faced by the institutions. Cross sectional regressions suggest that trade imbalances, enforcement of insider trading laws, stock prices, and an emerging market classification are positively associated with temporary volatility increases whereas the presence of market makers and better shareholders’ rights dampen such increases. In the long term, institutional trades do not destabilize markets as the levels of volatility after their trades are almost identical to their pre-decision levels.     

Price impact of block trades: the curious case of downstairs trading in the EU emissions futures market

Using high-frequency data from the European Climate Exchange (ECX), we examine the determinants of price impact of €21 billion worth of block trades during 2008–2011 in the European carbon market. We find that wider bid-ask spreads and volatility are characterised by a smaller price impact. Larger levels of price impact are more likely to occur during the middle of the trading day, specifically the four-hour period between 11 a.m. and 3 p.m., than during the first or final hours. Purchase block trades induce a relatively smaller price impact on price run-up, while sell block trades exhibit a larger price impact on price run-up. We conclude that block trades on the ECX induce less price impact than in equity or conventional futures markets, and that a significant proportion of the effects contradict findings on block trades in those markets; thus, we provide the first evidence of the curious bent to block trading in the European Union emissions trading scheme.     

Overconfidence among option traders

The investor overconfidence theory predicts a direct relationship between market‐wide turnover and lagged market return. However, previous research has examined this prediction in the equity market, we focus on trading in the options market. Controlling for stock market cross‐sectional volatility, stock idiosyncratic risk, and option market volatility, we find that option trading turnover is positively related to past stock market return. In addition, call option turnover and call to put ratio are also positively associated with the past stock market return. These findings are consistent with the overconfidence theory. We also find that overconfident investors trade more in the options market than in the equity market. We rule out explanations other than investor overconfidence, such as momentum trading and varying risk preferences, for our findings.     

Insider and liquidity trading in stock and options markets

We analyze the introduction of a nonredundant option, whichcompletes the markets, and the effects of this on informationrevelation and risk sharing. The option alters the interactionbetween liquidity and insider trading. We find that the optionmitigates the market breakdown problem created by the combinationof market incompleteness and asymmetric information. The introductionof the option has ambiguous consequences on the informationalefficiency of the market. On the one hand, by avoiding marketbreakdown, it enables trades to occur and convey information.On the other hand, the introduction of the option enlarges theset of trading strategies the insider can follow. This can makeit more difficult for the market makers to interpret the informationcontent of trades and consequently can reduce the informationalefficiency of the market. The introduction of the option alsohas an ambiguous effect on the profitability of insider trades,which can either increase or decrease depending on parametervalues.     

A note on execution costs for stock index futures: Information versus liquidity effects

This paper examines execution costs and the impact of trade size for stock index futures using price-volume transaction data from the London International Financial Futures and Options Exchange. Consistent with Subrahmanyam [Rev. Financ. Stud. 4 (1991) 17] we find that effective half spreads in the stock index futures market are small compared to stock markets, and that trades in stock index futures have only a small permanent price impact. This result is important as it helps to better understand the success of equity index products such as index futures and Exchange Traded Funds. We also find that there is no asymmetry in the post-trade price reaction between purchases and sales for stock index futures across various trade sizes. This result is consistent with the conjecture in Chan and Lakonishok [J. Financ. Econ. 33 (1993) 173] that the asymmetry surrounding block trades in stock markets is due to the high cost of short selling and the general reluctance of traders to short sell on stock markets.