The impact of options introduction on the volatility of the underlying equities: evidence from the Chinese stock markets

Abstract

The impact of options introduction on the underlying equities has been a topic of interest for decades, but mixed conclusions have been obtained in various financial markets, using different sample periods and methodologies. This paper examines the impact of the introduction of SSE 50ETF options on the volatility of SSE 50ETF using four different GARCH family models. For all models, we consistently find a significant decrease of the underlying equity volatility after the options introduction, along with an improvement of information flow on the underlying equity price. Further analysis shows that the impacts of speculative and hedging option trading activities are asymmetric. While the unexpected hedging trading activities decrease the volatility of SSE 50ETF, the unexpected speculative trading activities increase the volatility. Our empirical findings based on Chinese financial markets support the theory that options introduction attracts informed traders, and improves the information flow and liquidity of the underlying equities, and consequently reduces their volatility.