The interactions between trading volume and volatility: evidence from the equity options markets

Abstract

This study examines the relation between trading activity of equity options and the volatilities of the underlying equities. A sample of 45 companies with the most actively traded equity options at the Chicago Board of Options Exchange is selected and, for each company, equity price variability is compared with related stock and option trading volume. The significance of options trading activity in explaining the conditional volatilities of the underlying equities is comparable to that of stock trading activity, indicating a high degree of integration of the equity and the options markets. We also find that unexpected options trading activity contributes to enhanced volatility of the underlying equity returns. Finally, the analysis indicates that expected options trading activity significantly affects equity volatility in only a minority of firms. This is consistent with the contention that trading in the equity options market does not systematically lead to price destabilization in the underlying equity ...