Option Trading Research Articles

Activity of informed traders and stock returns

PurposeRecent studies suggested the ratio of option to stock volume reflected the private information. Informed traders were drawn to the options market for its leverage effect and relatively low transaction costs. Informed traders use different intervals of option moneyness to execute their strategies. The question is which types of option moneyness were traded by informed traders and what information was reflected in the market. In this study, the authors focused on this question and constructed a method for capturing the activity of informed traders in the options and stock markets.Design/methodology/approachThe authors constructed the daily measure, moneyness option trading volume to stock trading volume ratio (MOS), to capture the activity of informed traders in the market. The authors formed quintile portfolios sorted with respect to the moneyness option to stock trading volume ratio and provided the capital asset pricing model and Fama–French five-factor alphas. To determine whether MOS had predictive ability on future stock returns after controlling for company characteristic effects, the authors formed double-sorted portfolios and performed Fama–Macbeth regressions.FindingsThe authors found that the firms in the lowest moneyness option trading volume to stock trading volume ratio for put quintile outperform the highest quintile by 0.698% per week (approximately 36% per year). The firms in the highest moneyness option trading volume to stock trading volume ratio for call quintile outperform the lowest quintile by 0.575% per week (approximately 30% per year).Originality/valueThe authors first propose the measures, moneyness option trading volume to stock trading volume ratio, that combined with the trading volume and option moneyness. The authors provide evidence that the measures have the predictive ability to the future stock returns.

Reputation or court: Individualism, collectivism, and the choice of enforcement mechanism in exchange

Courts and reputation-based enforcement mechanisms are often employed to mitigate the problem of cheating in trade relationships. The choice between these two enforcement mechanisms is closely associated with individualistic/collectivistic cultural dispositions. Nevertheless, the selection of enforcement mechanism and how it relates to the reliability of third-party enforcement remains understudied. I designed a laboratory experiment in which the options for a safe local trade and a risky yet more profitable long-distance trade are available. When conducting Long-distance trade, subjects could employ a formal or an informal enforcement mechanism to oversee the trade relationships. I examined the subjects' choice of enforcement mechanism while controlling for their cultural disposition. Results suggest that those subjects with an individualistic disposition employ the court system (i.e., formal enforcement) more often than their collectivist counterparts when the court system is reliable. A belief elicitation task revealed that those with individualistic cultural orientation perceive new trade partners as more cooperative than their collectivist counterparts when trades are registered in a strong court.

Are stock and option trades substitutes or complements? evidence from the 2008 short-sale ban

Are stock and option trades substitutes or complements? evidence from the 2008 short-sale ban

Trading Preferences of Equity Derivative Traders in Kerala

The trading preferences of equity derivative traders has been examined in this study. The examination of objectives and preferences of equity derivative traders shows that earning speculative profit is the most preferred trading objective of derivatives traders, and the options market, index options and intra-day trade are the most preferred; market, instrument and trade respectively. Most of the options traders are showing interest in weekly expiring contracts and ATM options along with different market-based strategies while trading in the options market. Among 300 respondents, more than one-third of traders, square off their position when the market moves adversely without waiting for stop-loss, whereas a small majority reported that they modify their strategies in the event of adverse movement in the market.

Retail Trading in Options and the Rise of the Big Three Wholesalers

ABSTRACTWe document a rapid increase in retail trading in options in the United States. Facilitated by payment for order flow (PFOF) from wholesalers executing retail orders, retail trading recently reached over 60% of total market volume. Nearly 90% of PFOF comes from three wholesalers. Exploiting new flags in transaction‐level data, we isolate wholesaler trades and build a novel measure of retail options trading. Our measure comoves with equity‐based retail activity proxies and drops significantly during U.S. brokerage platform outages and trading restrictions. Retail investors prefer cheaper, weekly options with average bid‐ask spread of 12.6%, and lose money on average.

Overcoming Arbitrage Limits: Option Trading and Momentum Returns

AbstractMomentum profits depend mainly on the short leg and therefore on barriers to short sales. Our research indicates that the decline in momentum profitability in the past 2 decades is driven partly by a contemporaneous growth in stock options trading. Stock options offer an alternative to short selling, augmenting the stock lending market, and thereby contributing to improved pricing efficiency. The resulting reduction in barriers to short sales contributes to lower returns to momentum trading from the short leg. Our results persist after matching stocks with and without options based on different firm-level characteristics.

Why does operating profitability predict returns? New evidence on risk versus mispricing explanations

AbstractThis study develops new evidence on risk versus mispricing explanations of the well‐known profitability premium. First, we examine whether exposure to expected downside risk is a plausible explanation. We find that high profitability is associated with both lower ex ante and ex post probabilities of future price crashes. Thus, less profitable firms exhibit greater downside risk than highly profitable firms, making a downside risk explanation implausible. Although this fact is overlooked by the market in general, it is anticipated by options traders; we find that put options of low profitability firms are relatively more expensive. Simultaneously, these firms do not exhibit greater probability of jumps, indicating that volatility(risk)‐based explanations for the profitability premium are unlikely to be descriptive. Second, we find that the sticky‐expectations model of Bouchaud et al. (2019, The Journal of Finance, 74, 639–674) only partially explains the profitability premium. While on average, analysts' forecast revisions correct in the same direction as recent profitability, the profitability premium still exhibits a strong relationship to the non‐sticky component of analysts' forecast revisions. Third, institutional investors trade profitability‐based signals but do so with a delay, likely contributing to the premium. Overall, our evidence favours the explanation that the profitability premium is related to investor mispricing of potential downside risk and provides greater clarity on recent findings in the literature.

Who Profits from Trading Options?

We use account-level transaction data to examine trading styles and profitability in a leading derivatives market. Approximately 66% of active retail investors predominantly hold simple, one-sided positions in only one class of options, whereas institutional investors are more likely to use complex strategies. Hypothesizing that the complexity of trading styles reflects investors’ skills, we examine the effect of options trading styles on investment performance. We find that retail investors using simple strategies lose to the rest of the market. For both retail and institutional investors, selling volatility is the most successful strategy. We conclude that these style effects are persistent and cannot be fully explained by systematic risk exposure. This paper was accepted by Lukas Schmid, finance. Funding: J. Hu acknowledges financial support from Lee Kong Chian Fellowship. A. Kirilova acknowledges financial support from the Spanish Ministry of Science and Innovation [Grant PID2021-128994NA-I00]. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2023.4916 .

Research on the Development of Implied Volatility in Option Pricing

Option, as an important financial derivative, has received more and more attention from investors in recent years. This paper includes three parts, the first part introduces the concept of options, including the birth and history of options, the trading of options, and different types of options. Then it discusses the history of option pricing and two typical and classic option pricing models and then introduces implied volatility. The second part of this paper introduces the specific development of the option pricing models, the correction process of option pricing models, and volatility models. Different types of volatility, and their comparisons are included. And this paper also discusses the two functions of implied volatility, one is predicting the future and the other is for risk management and portfolio management. The third part concludes the first two-part and discusses the recent progress of option pricing and its volatility.

Automated cryptocurrency trading approach using ensemble deep reinforcement learning: Learn to understand candlesticks

Despite their high risk, cryptocurrencies have gained popularity as viable trading options. Cryptocurrencies are digital assets that experience significant fluctuations in a market operating 24 h a day. Recently, considerable attention has been paid to developing trading bots using machine-learning-based artificial intelligence. Previous studies have employed machine learning techniques to predict financial market trends or make trading decisions, primarily using numerical data extracted from candlesticks. However, these data often overlook the temporal and spatial information of candlesticks, leading to a limited understanding of their significance. In this study, we utilize multi-resolution candlestick images containing temporal and spatial information. Our rationale for using visual information from candlestick charts is to replicate the decision-making processes of human trading experts. To achieve this, we employ deep reinforcement learning algorithms to generate trading signals based on a state vector that includes embedded candlestick-chart images. The trading signal is generated using a multi-agent weighted voting ensemble approach. We test the proposed approach on two BTC/USDT datasets under both bullish and bearish market scenarios. Additionally, we use an attention-based technique to identify significant areas in the candlestick images targeted by the proposed approach. Our findings demonstrate that models using candlestick images 'as-is', outperform those using raw numeric data and other baseline models.

Priority host plants of the Queensland fruit fly, Bactrocera tryoni (Froggatt), based on the host reproduction number for tephritid management, surveillance and trade

The Host Reproduction Number (HRN) is a measure of the number of adult fruit flies that can emerge from one kilogram of fruit. HRN is a useful tool in surveillance, management and trade. I reviewed the literature for Queensland fruit fly (Qfly) and found data on 297 hosts. There were 81 Qfly hosts with HRN data and 216 Qfly hosts with no HRN data. The HRN will help to inform and triage hosts for target surveillance and management programs. Additionally, HRN will inform disinfestation activities pertaining to incursion response management, risk mitigation and trade options. There is a need for scientists to report HRN in a consistent manner so that Qfly management programs and trade protocols might be optimised.

COVID lockdown, Robinhood traders, and liquidity in stock and option markets

In this study, I investigate the impact of active option trading on stock market liquidity during the COVID-19 lockdown, particularly in connection with the rapidly growing retail trading activities during this period. I find that stocks with actively traded options, as well as those held by more Robinhood users, experience a lesser deterioration in liquidity during the US COVID-19 lockdown. However, a broader Robinhood user base appears to diminish the alleviation effect of actively traded options on the underlying stock's liquidity decline during the lockdown period. This observation is consistent with the postulation that informed traders shift away from option markets and towards stocks where the stock liquidity is improved. Further analysis suggests that, during the lockdown, a more extensive retail presence in the stock market is also associated with a narrower bid-ask spread in the option market. This finding supports the previous theories and empirical evidence suggesting that option market makers may offer tighter spreads when their hedging costs in the underlying market are reduced. Overall, this study presents novel evidence on the joint dynamics across stocks and options during the COVID-19 episode, and highlights the significant roles played by Robinhood traders in these dynamics.

Study on Knowledge of investors and impact of Advisory services on investment output in Future & options

Derivative trading was launched in India on NSE as well as BSE in the year 2000 and since then it has been witnessed that trading in Derivative segment is growing at a very high speed. If we look at the data for the last 10 years i,e. from 2012-13 to 2021-2022, the turnover of trading in options and Futures on Stock & index has moved from 31533003.96 cr to 1695233134.47cr (source: NSE). It has also been observed that nowadays most of the traders who were trading in equity segment only have started trading in future and options segment. The F&O contracts are used by the investors for variety of purpose such as hedging, speculation, arbitrage, profit maximization etc. It has also been observed that nowadays most of the individuals, who have little knowledge about stock market and trading, are entering into options and future trades and some of them are taking the services of some advisors for reaping maximum profit out of it. As per the current study conducted by SEBI, it has been observed that total number of traders who traded from the top 10 brokers in Indian in F&O segments has increased to 45.2 lakhs in the FY 22 from the 7.1 lakhs in the FY 2019. It shows that there is a significant increase of around 500% in the FY 2022 as compared to the FY 2019. The current study has been conducted to understand the awareness level and perception of investors towards making investment in future and options. The data has been collected from 102 respondents of Jammu & Kashmir who are actively involved in F&O trading through Non-random purposive sampling technique. After an in-depth review of literature, a comprehensive questionnaire was developed to collect the data that can be analyzed by using the relevant statistical tools to achieve the objectives of the study. The data shows that 76% of the respondents were aware about the F&O contracts available in the market and around 70% have knowledge about the concept of expiry in future and options. Regarding preference of investment in future & options only 50% of the investors are there who prefer to make investment in future & options. It has also been found that majority of the investors have gone for taking the help of financial advisors for making investment in future and options and chi-square analysis shows that there exists a significant relationship between investment output of the investors and advisory services taken by the investors

Behavioural Biases in Equity, Futures, and Options Trading: Implications for Market Efficiency

This research paper presents a comprehensive analysis of behavioural biases among traders operating in the equity, futures, and options segments of financial markets. The study aims to understand the psychological factors influencing trading decisions, risk perception, and trading strategies. By exploring the impact of behavioural biases on market efficiency and stability, this research contributes to the growing field of behavioural finance. Using a mixed-method approach, the study collected data through surveys, interviews, and behavioural experiments from a diverse group of traders, including retail investors and institutional participants. The analysis focused on identifying common behavioural biases such as overconfidence, loss aversion, herding behaviour, anchoring, and the disposition effect. The findings reveal that behavioural biases are prevalent among traders in all three segments. Overconfidence leads to excessive trading and underestimation of risks, while loss aversion influences risk aversion and reluctance to exit losing positions. Herding behaviour results in the formation of market bubbles and crashes, and anchoring affects traders' reliance on past information to make decisions. The disposition effect influences traders to hold onto losing positions longer than profitable ones. The study also highlights the impact of behavioural biases on trading strategies and risk management practices. Traders tend to exhibit risk-seeking behaviour during periods of market euphoria and become risk-averse during times of uncertainty and volatility. Moreover, behavioural biases can lead to suboptimal portfolio allocation and performance outcomes. The implications of these findings for market efficiency and stability are significant. Behavioural biases can contribute to market inefficiencies, distorted price patterns, and increased market volatility. As a result, market participants and regulators must address these biases to foster more informed decision-making and improve market outcomes. To mitigate the impact of behavioural biases, the study recommends trader education programs focusing on behavioural finance principles and risk management techniques. Additionally, market regulators should implement measures to promote transparency and discourage excessive speculative trading. In conclusion, this research underscores the importance of understanding behavioural biases in equity, futures, and options trading. By shedding light on the psychological drivers of trading behaviour, this study provides valuable insights for traders, financial institutions, and policymakers to enhance market efficiency and stability in the face of behavioural challenges.

The Effects of Option Trading Behavior on Option Prices

This paper investigates the relationship between option trading behavior and option pricing patterns. We argue that greater active trading in the options market due to investor overconfidence leads to higher volatility and larger discrepancies in option pricing, which may be captured by implied volatility spread and implied volatility skewness. Using two different measures of excess option trading, we find that trading activities are correlated in different ways with volatility, volatility spread, and volatility skewness. We also find that these relationships exist both over time and cross-sectionally. We suggest that options investors tend to chase “hot” stocks, as we find evidence of a positive relationship between option trading activities and past underlying equity returns. Heavier trading in the options market also tends to make out-of-the-money call options more (less) expensive than the at-the-money counterparts over time (cross-sectionally). Because trading activities do not predict future equity returns, investor overconfidence, and not informed trading, seems to be a more plausible explanation for our findings.

Drivers of winegrowers' decision on land use abandonment based on exploratory spatial data analysis and multilevel models

The frequency of producers opting to abandon agricultural land has become increasingly, highlighting the significance of this phenomenon due to its environmental, landscape, and socio-economic impacts. The decisions of producers to abandon or maintain/improve their farms depend on individual and contextual factors. The aims of this research are twofold. Firstly, to evaluate the influence of the neighbours on the winegrowers' decisions, using spatial analysis. Secondly, to clarify the specific importance of each of the individual and contextual drivers in farmers' decisions to improve their farms, to keep them unchanged or to abandon them, using multilevel models. The results obtained for the case study of vineyards in Spain, reveal a strong agglomeration phenomenon in farmers' decisions indicating that producers make land use decisions influenced by what their neighbours do. A multilevel analysis identifies that individual factors are determinant and that the influence of contextual factors is conditioned by the innovation process at farm level. Individual drivers, such as size, innovation, Protected Designations of Origin and irrigation influence vineyard area, with irrigation having the greatest overall influence, and is expected to be decisive in climate change projections. The Protected Designations of Origin are driving forces that dynamize the territory and achieve productive concentrations, encouraging winegrowers to replant, but they are not enough to halt abandonment. The elements that slow down the abandonment of plots are irrigation and the combination of innovation and context variables, mainly the combination of modernised plots in the municipalities with trading options.

Informed trading prior to financial misconduct: Evidence from option markets

This paper shows an abnormal level of option trading activities in the ten days before the revelation of financial misconduct in a sample of the SEC and/or DOJ enforcement actions. These abnormal option trading volumes are negatively associated with the subsequent stock returns to the announcements, and are positively linked to firm penalty, the number of violations, prison sentences, fraud charge, top executives number, potential firm deception toward auditors, impeded investigation, and violation period. Finally, abnormal option trading is related to the time to discovery and the likelihood of discovery. These results suggest that option traders detect firms engaged in financial misconducts.

Price dispersion and the stability of trade*

AbstractResearch on trade relationships has documented a high rate of relationship breakup and churning. We use data on Norwegian exports to document two stylized facts about the stability of trade relationships. First, the probability of relationship breakup increases in the deviation of the relationship‐specific price from a reference price. Second, relationship hazards follow Zipf's law. We propose a search model with limited information and search frictions to explain these facts. Reference prices provide information on outside trade options that inform optimal breakups, leading to the first stylized fact. Strong heterogeneity in breakup frictions across relationships can explain the Zipf's law hazards.

정보거래자의 옵션 선택에 관한 연구

Purpose - The purpose of this study is to examine the option selection and optimal trading of informed traders in KOSPI 200 options market based on the PIN (probability of informed trading) model of Easley et al.(2002). Design/methodology/approach - This study uses TAQ (trade and quote) data provided by Korean Exchanges (KRX) which contains all the bids and trades recorded during the continuous auction trading hours for the KOSPI 200 options between May 2019 and September 2020. Findings - First, there was no difference in the PIN between call and put options in the 2019 data, but the PIN of put options was slightly higher in 2020. Second, regardless of the type of option, the PIN was higher for in-the-money (ITM) options, and the PIN of out-of-the-money (OTM) options was the same as or slightly higher than that of at-the-money (ATM) options. Third, we found that the PIN decreases as trading liquidity increases, and fourth, the PIN increased sharply as the expiration date approached, especially for OTM options, while ITM and ATM options showed relatively weak effects. Fifth, for foreign and institutional investors, the periodicity of orders was observed in milliseconds, especially for foreign investors, where the periodicity of orders was clear and frequent in OTM options. The results suggest that the purpose of option trading varies depending on the moneyness from the perspective of the informed trader.

The Legal Problems of Weakness Supervision of Binary Option in Indonesia

This article aims to find out and assess the forms of binary option supervision in Indonesia contained in statutory regulations. This article discusses the legal problems of the weakness of binary option supervision in Indonesia. This research uses normative research methods using primary and secondary legal materials collected using literature studies with a statutory approach.
 This study found that although supervision of commodity futures trading in Indonesia has been carried out by Bappebti, there are still problematic weaknesses in supervising binary option trading which is currently a new trend in Indonesian society. Futures trading in Indonesia is regulated in Law No. 10 of 2011 concerning Commodity Futures Trading. Bappebti's supervision has legal problems, namely in the form of the absence of a special regulation on binary option trading, lack of education for the public, imposition of sanctions that are less strict, and the existence of legal vagueness. Bappebti is expected to have a legal strategy in optimizing binary option supervision in Indonesia in the form of: making strict regulations, socializing to the public about the dangers of illegal investment, increasing financial and investment literacy, and can cooperate with foreign regulators to improve binary option supervision in Indonesia.