Abstract
Underlying each stock trades hundreds of options at different strike prices and maturities. The order flow from these option transactions reveals important information about the underlying stock price movement and its volatility. How to aggregate the trade information of different option contracts underlying the same stock presents an interesting and important question for developing microstructure theories and price discovery mechanisms in the derivatives markets. This paper takes options on QQQQ, the Nasdaq 100 tracking stock, as an example and examines different order flow consolidation schemes in terms of their effectiveness in extracting information about the underlying stock price and volatility movements. The analysis shows that an effective consolidation scheme shall account for both the liquidity of each option contract and the contract’s particular exposure to stock price and volatility movements. Based on our proposed consolidation scheme, we identify significant relations between the appropriately aggregated options order flows and the ex post stock returns and return volatilities. In particular, the aggregated stock buy pressure positively predicts future stock returns and the aggregated volatility buy pressure positively predicts future changes in return volatilities up to five minutes.
Published Version
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