Informed traders and their market preference: Empirical evidence from prices and volumes of options and stock

The causal structure of price and volume in options and stock markets is examined to investigate whether a preferred market for informed trading exists. The possible trade-off of leverage on one hand and liquidity and transactions costs on the other, and the effect of different market mechanisms, are discussed in this context.We test for cointegration and use the vector error correction (VEC) approach if we find it. Otherwise, causality tests are via the conventional vector autoregression (VAR). We find that volume leads price in both markets, but that option volume leads stock volume, and stock price leads option price. These results differ from previous studies. Potential explanations are discussed.