Informed trading, trading strategies and the information content of trading volume: Evidence from the Taiwan index options market

Abstract

This paper examines the predictive ability of index option put-call volume on next-day index movements in the Taiwan market. We find that foreign institutional investors are the most informed traders, with their predictive ability being more apparent in a downward market. When engaging in informed trading, foreign institutional investors tend to use out-of-the-money options to achieve high leverage, along with medium-term options to obtain large delta exposure and low theta risk, whilst also sacrificing liquidity by forgoing the use of short-term options. The predictive ability of foreign institutional investors is found to be significantly enhanced on days with important macroeconomic news, thereby indicating their superior interpretative ability of publicly accessible information. Based upon their long-lived informational advantage, foreign institutional investors will tend to engage in informed trading using limit orders and medium-sized trades in order to camouflage their information.