Net Buying Pressure and Informed Trading in the Options Market: Evidence from Earnings Announcements

Ihsan Badshah,Hardjo Koerniadi

doi:10.3390/jrfm15020053

Abstract

By employing the modified net buying pressure as a measure of informed option trading, this study tested whether option trading around quarterly earnings announcements is either directionally motivated and/or volatility motivated. We found evidence that is consistent with the idea that option investors have private information prior to positive earnings announcements and use at-the-money options to exploit their informational advantage. In the post-event period, however, informed option investors trade by using deep-out-of-the-money and out-of-the-money options. We documented limited evidence on the volatility-motivated option trading, and our results suggest that this type of option trading could be motivated by hedging purposes only.

Highlights

The literature reports that option investors trade on the volatility of underlying stock returns (e.g., Patell and Wolfson 1981; Gharghori et al 2017; Chen and Wang 2016)
Except for Kang and Park (2008) and Chen and Wang (2016), prior studies do not differentiate trading strategies of these two types of option investors.1. To fill this gap in the literature, this paper examines US option investors’ trading prior to quarterly earnings announcements with respect to both expected changes in stock returns and the volatility of stock returns related to the event
Following Chen and Wang (2016) and Gharghori et al (2017), we examined whether option trading measures of volatility-motivated informed trading are related to stock return volatility based on the following regression specifications: STDEVSHORT (−1, +1)i = Intercept + αPRE_NBPVik + βBASE_NBPVik + ε i

Summary

Introduction

The literature reports that option investors trade on the volatility of underlying stock returns (e.g., Patell and Wolfson 1981; Gharghori et al 2017; Chen and Wang 2016). Except for Kang and Park (2008) and Chen and Wang (2016), prior studies do not differentiate trading strategies of these two types of option investors.1 To fill this gap in the literature, this paper examines US option investors’ trading prior to quarterly earnings announcements with respect to both expected changes in stock returns and the volatility of stock returns related to the event. Kim and Verrecchia’s (1991, 1994) information-based trading theory suggests that informed investors trade, on private information prior to an event, but could trade in the post-event period due to their superior ability in processing publicly disclosed information from a corporate announcement To test this conjecture, we examine the relation between net buying pressures and both stock returns and stock return volatility during the post-event window.

Research Design

Directional-Motivated Options Trading

Volatility-Motivated Options Trading

Post-Event Options Trading

Conclusions