Does Information Drive Trading in Option Strategies?

Abstract

We study trading in option strategies such as straddles, strangles, vertical and horizontal spreads using a unique sample of all trades in individual options and option strategies on the FTSE-100 index. In our sample, trades in option strategies represent around 38% of the total number of trades and over 80% of the total trading volume. Consistent with at least some traders using option strategies to speculate on the future direction and volatility of the index we observe more active trading in strategies in weeks with high index volatility and in weeks with macro announcements. We report evidence consistent with trading in option strategies containing some non-public information. On average, the at-the-money implied volatility increases by approximately 40 basis points over a period of five days before to five days after buyer-initiated trades in option strategies that are long volatility. We also report evidence that the market conditions prevailing when strategy trades are initiated vary systematically. Bull spreads tend to be both bought and sold more actively following positive market returns whereas bear spread are both bought and sold in markets with negative returns. Both strategies tend to be most actively traded in high volatility periods.