INFORMATION ASYMMETRY AND OPTIONS TRADING |
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| Authors: | Christopher K. Ma Ramesh P. Rao |
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| Affiliation: | University of Pittsburgh, Pittsburgh, PA 15260, and University of Toledo, Toledo, OH 43606.;Texas Tech University, Lubbock, TX 79409, and University of Toledo, Toledo, OH 43606. The authors appreciate the comments of Lawrence V. Conway, Herb Weinraub, and the participants of the Finance Seminar Series at the University of Toledo. We thank Christopher Lamoureux and two anonymous reviewers for their comments on an earlier version of this paper. Financial support for this research was provided by the Academic Challenge Grant and the Faculty Development Fund of the University of Toledo. |
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| Abstract: | This paper demonstrates that options trading does not have a uniform impact on the volatility of underlying stocks. Although uninformed traders are able to hedge the risk of underlying stocks by maintaining opposite positions in the options market, informed traders hold outright options positions to capitalize on their information. This hedging behavior tends to reduce noise in the stock market, whereas the speculating behavior tends to generate noise in the stock market. As a result, stocks that were originally volatile, i.e., traded primarily by uninformed traders, will be stabilized by the introduction of options. Conversely, stocks that were more stable become destabilized by options trading. |
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