Does informed rading occur in he opions marke? Some revealing clues Blasco N.(1), Corredor P.(2) and Sanamaría R. (2) (1) Universiy of Zaragoza (2) Public Universiy of Navarre Absrac This paper analyses he relaionship beween proxy variables for informed rading in he opions marke and a se of exogenous news variables. The aim is o es direcly for he presence or absence of informed rading in he opions marke and for he possible impac of his rading on underlying asse prices. Our findings reveal ha poenial informed rading in opions markes is channelled basically hrough ou-of-he-money opions (OTM), excep for volailiy rading which mainly involves a-he-money opions (ATM) because of heir liquidiy. In boh cases, we have found evidence in favour of invesors' sraegic fragmenaion of ransacions ino inermediae size rades (sealh rading). Finally, i is shown ha lack of consensus among agens also generaes increased rading, paricularly in OTM opions. Keywords: Opion Volume, News, sock prices JEL Classificaion: G13, G14, C22
Does informed rading occur in he opions marke? Some revealing clues Inroducion Opion rading volume may be driven by one of wo clearly differeniaed facors: hedgeliquidiy or informaion. While he firs is easy o explain, he second is less obvious and has herefore been he source of some conroversy in he lieraure. The argumen in favour of he informaion conen of opion rading volume is grounded on cerain characerisics of opions, such as higher leverage or he opporuniy o be on volailiy, ha make hem aracive o informed raders. Neverheless, hese argumens migh be counered by heories based mainly on he lower liquidiy of opions in relaion o he underlying marke. Mos of he exising analyses of his issue have urned o he empirical evidence in an aemp o sele he conroversy. The general approach has been o search for variables relaing o opions rading volume ha will serve as good proxies for informed rading. These include he pu/call raio, asymmery, and posiive and negaive volume, among ohers. There is scan evidence, however, of any aemp o es his assumpion direcly. Our objecive, herefore, is o show wheher opions rading is due o he behaviour of informed invesors acing on a direc informaion source, and deermine he ype of opions in which such invesors are more likely o rade. Our firs sep in his analysis is o es wheher opions rading affecs underlying asse prices. A necessary, hough no sufficien, condiion is ha if his opion rading is moivaed by new informaion, i should be possible o deec a significan impac on he underlying asse price 1. Oherwise he informaion embedded in opions rading would be redundan. To confirm such a necessary condiion, we will begin by analysing he impac of overall opions rading volume on underlying asse reurns. However, in line wih recen lieraure, we will also focus on he impac of posiive and negaive opions volume and he imbalance of hese, since overall volume may conceal oher facors apar from rading. Once hese assumpions have been confirmed, he nex major sep will be o analyse wheher hese rading volumes are informaion driven. This undoubedly key issue in he analysis is no easy o address, however. Our main conribuion in his framework is our proposal for direc esing using a daabase conaining all he announcemens published in he economic press during he period of analysis. This daabase, which has been used in wo previous sudies (Blasco e al. (2002) and Blasco e al. (2005)), concerns he Spanish sock marke. In his way we are able o esablish a direc relaionship beween news and rading volume in a financial derivaive. In his framework, he mos novel feaure of our 1 The significan link beween opions volume and underlying asse prices migh be due o oher facors, such as hedging, alhough in his case he effec would be ransiory. 1
sudy is ha i focuses on rying o see wheher facors such as differen levels of liquidiy and /or degrees of leverage affec he informaion conen in opion rades and, hus, if some ypes of opions show more signs of informed rading. From his daabase we will conruc a proxy variable for lack of consensus beween agens. This variable will allow he direc esing of an addiional hypohesis, ha is he possibiliy of a posiive relaionship beween he volume of rading and divergence in invesors expecaions. This should also yield useful findings for a beer undersanding of his phenomenon. Finally, volume is pariioned ino he number of ransacions and average rade size, in order o es wheher informed rading drives sraegic pracices based on he fragmenaion of ransacions ino medium-size rades, which helps o camouflage invesors inenions and conceal privae informaion from oher marke agens (see Barclay and Warner, 1993). These daa will also enable us o idenify feaures ha are unobservable in he aggregae daa. To sum up, our main conribuions o he lieraure are he following. Firs, we es direcly wheher opions rading can be explained by informaion. Such informaion is idenified wih a daabase of news classified ino good news or bad news. The classificaion is ex-ane. I jus depends on he assessemen suggesed in he financial press. Second, his sudy considers he effec of divergence of invesors expecaions on rading volume using he exogenous news daabase. Third, he pariion of he rading volume ino he number of ransacions and average rade size enables us o deermine if hese componens are relaed o news releases and o he divergence in invesors expecaions. Finally, his paper focuses on he Spanish marke which is smaller in size and imposes higher shor selling consrains 2 han he US marke analysed by oher auhors. This fac may help us o gain a fuller undersanding of he relaionship beween opion rading volume, informaion, and underlying asse prices. The remainder of he paper is organised as follows: he nex secion summarises he main heoreical argumens on which he analysis is grounded and briefly reviews he mos significan empirical sudies. Secion 3 presens he mehodology, he hypoheses and he associaed ess. Secion 4 describes he daabase; secion 5 conains a discussion of he resuls; and secion 6 presens he main conclusions. 2-Theoreical framework and previous lieraure The heoreical moivaion for our analysis comes from he growing lieraure on how o incorporae condiioning informaion in asse-pricing models. This is he cenral issue of all 2 In Spain, shor selling is ypically concenraed in he Credibolsa sysem, mainly on socks in he Ibex-35 (he 35 Spanish blue chips). Posiions can be held for no longer han 90 days. However, here is anoher possibiliy, securiies lending via OTC, which is no resriced o he Ibex-35, nor is i subjec o such a sric ime limi. 2
informaion-based models, which differ in heir modelling approach bu coincide in incorporaing informaion ino sock prices as he resul of informed and uninformed rading. Two major references in his vein are Glosen and Milgrom (1985) and Easley and O Hara (1987). The consideraion of derivaives inroduces a new marke on o he scene, hus enriching he exising lieraure, since i adds o he relaionship involving rading, prices and privae informaion a new ype of asse ha may incorporae furher informaion and hereby affec he pre-exising relaionships. Some sudies ha include derivaives in hese relaionships are: Grossman (1988), Back (1993), Biais and Hillion (1994), Brennan and Cao (1996), Easley, e al (1998) and John, e al (2008), among ohers. The key issue, however, is o analyse he reasons why informed invesors migh be persuaded o rade in he opions marke. In his respec, auhors such as Black (1975) or Mayhew e al (1995), among ohers, argue ha he aracion of opions rading lies in lower ransacion coss and higher leverage in relaion o he underlying asses, and he lack of shor sales consrains in hese markes. Back (1993) and Cherian (1993) poin ou, furhermore, ha invesors ha be on volailiy can only do so in he opions marke. Neverheless, wha migh dissuade invesors from engaging in he above pracices is a possible preference o rade in he underlying asse marke, which offers a higher level of liquidiy han he opions marke. Among he mos ousanding sudies on he effec of opion rading volume on underlying asse prices we migh menion Easley e al (1998), Chan e al (2002), Chen e al (2005), Schlag and Soll (2005) and Pan and Poeshman (2006). These sudies are no conclusive, since hey yield mixed resuls. There are oher works, however, ha analyse hese relaionships around specific evens. Such is he case of Amin and Lee (1997), who find ha a greaer proporion of long (or shor) posiions are iniiaed in he opion marke immediaely before good (or bad) earnings news on he underlying sock, and Cao e al (2005), who find ha he call volume imbalance prior o akeover announcemens is srongly relaed o nex day sock reurns. Exceping for he paper by Nofsinger and Prucyk (2003), we have no found direc analyses of he relaionship beween opion rading volume and public announcemens in he press. These auhors use a regression procedure o examine S&P 100 sock-index opion volume and implied volailiy around scheduled macroeconomic announcemens. As many official announcemens of economic indicaors are scheduled in advance, ineresed marke paricipans know he exac day and ime of he announcemen. Their findings indicae ha boh rading and volailiy increase subsanially afer bad news is released. Paricularly, Consumer Credi, Consumer Spending, Facory Invenories, NAPM and Non- Farm-Payrolls elici he higher rading response. 3
The relaionship beween opion rading volume and public announcemens or news published in he press can help o clarify many of he assumpions made in he heoreical hypoheses pu forward in he lieraure, since i enables us o esablish a direc relaionship beween volume and news. Unlike Nofsinger and Prucyk (2003), we are dealing wih unscheduled announcemens and here are no prior expecaions for heir poenial impac on prices, herefore he impac can be inerpreed in general erms and no merely as he surprise ha would follow an expeced announcemen. I should be noed, moreover, ha our sudy analyses he impac of news on hose volume variables ha we have previously found o be poenial informed rading measures because hey have a significan impac on underlying asse prices. Furhermore, our sudy examines he differences in he resuls on informed rading in he opions marke across differen degrees of moneyness as well as he impac of news on he componens of rading volume. No all hese aspecs have been addressed by he auhors menioned. 3-Hypoheses and associaed ess 3.1-Underlying asse prices and opions rading volume. The firs sep is o es wheher opions rading affecs underlying asse prices. Following he lieraure, we firs explore he conemporaneous relaionship beween underlying asse reurns and volume raded in he corresponding opions marke. The empirical model for analysing his relaionship has he following form: P = 0, s β1, s P 1 β 2, s X s, u, s β ; ( ) u φ N 0, ), s / 1 ( h,s = α α ϖ (1) 2 h, s 0, s 1, su 1, s 1, sh 1, s where P is he naural log of he price of he underlying asse, X is he variable ha proxies for he level of informed rading in he opions marke and φ is he informaion se available on day. X is no an obvious choice. In fac, he lieraure has proposed several differen measures for his purpose, including overall volume, posiive and negaive volume, and imbalance among ohers. In he above expression, he subscrip s refers o he differen measures of volume considered, as will be discussed laer 3. Given he presence of significan firs order auocorrelaion, we include he lagged dependen variable in he regression. We use condiional volailiy models, specifically he GARCH(1,1) specificaion 4, because Engle s ARCH es revealed he presence of significan ARCH effecs. 3 Lagged Xs,, has also been used in previous esimaions, bu i was no significan in all cases (overall volume, posiive or negaive volume or imbalance); he final esimaion herefore includes only he conemporaneous variable. As will be explained laer, hese resuls indirecly suppor he informaion hypohesis. 4 The analyses were also performed including an asymmerical variance specificaion (he GJR model). The resuls obained do no aler hose repored here. 4
In his regression he main issue is o analyse he sign of β2,s, and he facors ha may lie behind he esimaed value. In a perfec marke all news would immediaely be made public and available o all marke agens; quoes would immediaely adjus o he informaion, and rading would convey no addiional informaion. This would lead o an expeced value of β2,s=0. In conras, on he basis of argumens presened in Schlag and Soll (2005), if opions rading volume has an impac on underlying asse prices, he coefficien should be β2,s>0 and significan. As a consequence, he firs null hypohesis o es is H1: β2,s=0. If we rejec his null hypohesis we will have empirical evidence in favour of he impac of opions rading on he underlying asse prices. Deviaions from 0 could be explained eiher by informaion or hedging (liquidiy) effecs. When i has o do wih informaion, i is acknowledged ha ransacions in he opions marke may carry informaion ha is no refleced in prices in oher marke, hus lending suppor o he argumen ha informed invesors rade in he opions marke. In our case, however, we are dealing wih a sock index; i is herefore hard o believe ha invesors will have privae informaion abou all he componen socks. I canno be ruled ou, however, ha invesors may use indexes o adjus he leverage in heir porfolios when in possession of privae marke-wide informaion arising, for example, from general news circulaing in he financial markes. This would lead o permanen price effecs 5. The oher siuaion ha could give rise o β2,s being differen from 0 is when hese asses are used for hedging purposes, which would mean ha all opions rading would be based on liquidiy and herefore rading volume iself would no be informaive. In his case he relaionship is ransiory 6 because of he emporary price impac. Despie he appeal of hese argumens, he esimaion of parameer β2,s canno be considered a direc es of he relaionship beween opions volume and informaion. Furhermore, he possible presence of informed rading does no rule ou he possibiliy of opions being raded for hedging or liquidiy purposes. Therefore, overall volume may include invesors wih diverse objecives, hus complicaing he ask of disinguishing beween permanen and emporary effecs. The es proposed here, however, allows for a direc examinaion of he relaionship beween informaion and volume, wih no need o ener ino any furher consideraions. Reurning o our line of reasoning, firs we will sudy he relaionship beween he proxies for informed rading volume in he opions marke and variaions in underlying asse prices. As noed earlier, he lieraure repors he use of several proxies for informed rading. In his paper we use hree alernaive measures. The firs is aggregae opions rading volume on day. The firs regression o be esimaed will herefore be given by: P = β P β Vol u β ; ( ) 0,1 1,1 1 2,1,1 u φ N 0, ), 1 / 1 ( h, 1 5 This would mean ha he coefficiens of he lagged volumes would be equal o zero (see Schlag and Soll, 2005) 6 According o Schlag and Soll (2005), we would find lagged volumes wih negaive coefficiens due o he reversal effec. 5
h α α ϖ (2) 2, 1 = 0,1 1,1u 1,1 1,1h 1,1 The second alernaive measure uses posiive and negaive volume. Posiive volume (vol ) is he volume of calls purchased plus volume of pus sold on day and negaive volume (vol - ) is he volume of calls sold plus volume of pus purchased on day. For his analysis, we esimae he following regression 7 : 0,2 β1,2 P 1 β 2,2vol β 3,2vol u,2 β ; ( ) P = u φ N 0, ), 2 / 1 ( h, 2 h α α ϖ (3) 2, 2 = 0,2 1,2u 1,2 1,2h 1,2 In he hird alernaive, volume is capured by imbalance (IB), he difference beween posiive and negaive volume on day. Formally, he esimaion is defined as follows: P = β P β u β ; ( ) 0,3 1,3 1 2,3IB,3 u φ N 0, ), 3 / 1 ( h, 3 h α α ϖ (4) 2, 3 = 0,3 1,3u 1,3 1,3h 1,3 3.2-Opions volume and informaion In he case of having rejeced he H1 null hypohesis, he resul suppors he exisence of a conemporaneous relaionship beween he spo price and volume in opions, signed volume in opions, or he imbalance beween posiive and negaive volume. The nex sep now is o es he informaion ha his conveys. In oher words, we seek o deermine wheher volume occurs as a resul of he release of news, a claim ha has been aken as a premise in he lieraure bu has never been direcly proven. The only exising evidence is ha presened by Nofsinger and Prucyk (2003), who found ha opions volume is posiively relaed o news bu did no demonsrae in advance wheher his aggregae volume had a price impac on he underlying asse (he rejecion of he H1 null hypohesis), and herefore wheher he relaionship was unequivocably due o informed rading in he opions marke. In overall erms, volume should be relaed o news, eiher hrough he release of exogenous informaion, be i public or privae, (ε), or hrough endogenous informaion (conveyed hrough rading), (η). To his we need o add he volume resuling from liquidiy/hedging rades (θ). Mahemaically, rading volume can herefore be wrien as: Vol = f (ε, η, θ ). (5) In his secion we analyse he relaionship beween volume in opions and exogenous news, in order o es for he exisence of informed rading in opions, as well as he poenial effec of privae informaion on he componens of opions rading volume (number of ransacions and average rade size). 7 As argued by Schlag and Soll (2005), he shorcoming of running separae regressions for posiive and negaive volume is ha i rules ou he possibiliy of conrolling for poenially offseing volume effecs. 6
3.2.1 Opions volume and response o news Since our main concern in his sudy is he relaionship beween volume and privae informaion, we need o focus on hose volume measures ha affec spo prices and may herefore serve o measure informed rading. I should be noed, moreover, ha, in order o gain a proper undersanding of his issue, i seems more correc o relae, no rading volume, bu unexpeced volume o news, in order o deec wheher surprises in volume are due o news release or o evens of anoher naure. Thus, he problem o be analysed can be formulaed as follows: UVol = λ 0 λ1gn λ2bn λ3. R ˆ u, UV UVol = Vol -E( Vol /φ -1 ) ; E( Vol /φ -1 )=ARMA(p,q) (6) This empirical model relaes unexpeced rading volume UVol o general good and bad news releases in he Spanish financial press 8, using an error erm ha capures he impac of endogenous informaion revealed hrough marke rading and hedge or liquidiy rades. The variable Vol denoes oal (Vol), posiive (vol ) or negaive (vol - ) opions rading volume or imbalance. GN sands for he dummy variable for good news and BN is he dummy variable for bad news. The subscrip in he dummy variables for news indicaes ha such informaion is published by he financial newspaper on day 1 even hough i is available for informed agens on day. In order o avoid misleading conclusions if opion invesors simply respond o movemens in he underlying marke in a rend-following way, i would be ineresing o include he underlying asse reurn along he rading session as an addiional explanaory variable 9. Neverheless, given ha his reurn may also be affeced by good and bad news, we find i preferable o include he news-adjused reurn on daily session ( Rˆ ) afer filering he influence of GN and BN 10. Expeced volume is esimaed by means of an ARMA model (p,q) o find he bes fi for he daa 11 The null hypohesis H2: λ1=λ2=0 indicaes ha he abnormal rading volume does no relae o exogenous informaion (proxied by exogenous news). In performing his analysis we aim o link up wih he lieraure addressing he issue of how informed rading in he opions marke is disribued across differen degrees of 8 The analysis was also repeaed using he op and boom quiniles of he residual of he index as he reference when creaing he dummy variables o proxy for good and bad news respecively. The resuls lead o he same conclusions ha can be drawn when using he press announcemen. This validaes is use since hese news releases are spread hroughou he rading day, while he residuals used as an alernaive are only accessible expos. 9 We would like o hank an anonymous referee for his suggesion. 10 In he case of he Spanish sock marke, good news is posiively significan a he 5% significance level and bad news is negaively significan a he 0% significance level when explaining he underlying asse reurn. As an addiional robusness es, we alernaively include overnigh reurn (ha is assumed o reflec oher informaion han news) and raw reurn, respecively, as explanaory variables. The conclusions remain unchanged. All hese resuls are available upon reques. 11 In mos of he series analysed, he final specificaion was an AR(2). However, he resuls do no differ significanly from hose obained using oher specificaions, such as AR(5). Our proposal differs from ha presened by Nofsinger and Prucyk (2003) in ha hese auhors analyse differences in rading volume during 30- minue even windows. 7
moneyness. Chakravary e al (2004) and Chen e al (2005) argue ha his is a key issue because opions wih differen degrees of moneyness have differen levels of liquidiy and differen degrees of leverage. The heory also suggess various facors ha migh influence informed invesors when making he choice beween one srike price and anoher. Thus, on he one hand, hough OTM opions provide invesors wih more leverage, hey also end o involve higher dela-o-premium raios, due o higher bid-ask spread and commissions. In ATM opions, bid-ask spread ends o be lower, so invesors rading on volailiy end o concenrae heir rades in hese. On he oher hand, ATM opions also expose informed invesors o higher volailiy risk (vega). Finally, ITM opions generally involve lower commissions. The relaive imporance of hese compeing facors is an empirical quesion ha has ye o be resolved. Chakravary e al (2004), for example, find ha price discovery is higher in OTM. Invesors aiming o make he mos of heir privae informaion should prefer o rade in opions wih he highes possible dela-o-premium raio (Chen e al (2005)). Therefore, any sudy ha fails o incorporae his issue runs he unavoidable risk of confounding he empirical resuls. In ligh of his lieraure, i appears reasonable o suspec ha daily volume in all posiions may be masking differen inenions among invesors rading in opions wih differen degrees of moneyness. Following he suggesion of Easley e al (1998), we will aemp o explore he informed rading hypohesis by considering paricular opions series. An informed invesor may make more by rading in he opions conracs wih he highes leverage (OTM), while invesors rading on volailiy will end o concenrae on ATM opions. Those aiming o hedge, meanwhile, will likely op for opions conracs offering high liquidiy, which will also be easier o find in ATM conracs. To overcome his problem, we will break down opions rading volume ino ATM, OTM and ITM opions and esimae he regression equaion described above for each of he hree groups. The daabase addiionally allows us o explore he issue of invesor disagreemen. In paricular, as is shown in he daa descripion, four news scenarios are possible each day. News can be good, bad, mixed or absen. Assuming he coexisence of good and bad news on a single day o be a poenial source of invesor disagreemen, i is possible o mainain he hypohesis ha, ceeris paribus, such days will cause a greaer divergence of opinion han migh occur on a good news day, a bad news day or a no news day. The dummy variable DO, divergence of opinion, was creaed in order o examine he relaionship beween unexpeced volume and invesor disagreemen. This variable will ake a value of 1 for days when here is boh good and bad news and a value of 0 oherwise. Wihin his framework, in order o es he explanaory power of divergence of opinion (DO) for poenially informed rading, we propose a regression for unexpeced volume similar o ha used for news releases. The regression esimaed in his case is given by: UVol = γ 0 γ 1DO γ 2R ˆ u, UVD 8
UVol = Vol -E( Vol /φ -1 ) ; E( Vol /φ -1 )=ARMA(p,q) (7) The H3: γ1=0 null hypohesis indicaes he divergence of opinion is no an explanaory variable for he unexpeced opions volume measures. 3.2.2 Componens of opions rading volume and response o news. Finally, if our resuls indicae he rejecion of hypoheses 1 and 2 (or even hypohesis 3 alhough i is no necessary for our nex empirical purpose) and, herefore, we find favourable evidence abou he exisence of informed rading in he opions marke, i becomes relevan o invesigae wheher privae informaion increases he incenive for invesors o rade sraegically, camouflaging heir inenions by ordering smaller rades ha give away less informaion o oher raders. In his secion, we will examine his issue by considering he componens of rading volume: he number of ransacions and average rade size. According o Barclay and Warner (1993), in he presence of informed rading, here is a higher incenive for raders o make medium-size rades in order o camouflage heir sraegy and hus avoid revealing informaion. This sraegy, known as sealh-rading, leads invesors o increase heir rading frequency and exhibi a preference for medium-size rades. Wha follows is an increase in he number of rades and some reducion in average rade size. A breakdown of he daa would enable us o deermine wheher any significan changes ha migh have aken place in eiher of hese variables have been offse by he impac of he oher variable. More specifically, i is possible ha he number of rades migh increase while he average size decreases, hus giving he impression ha volume remains unaffeced. Our proposed esimaion o analyse he impac of informed rading on he number (T) and average size of rades (TS), relies, like previous esimaions, on he unexpeced values of he relevan variables. More specifically, UT denoes he number of unexpeced rades in period and UTS denoes he average size of unexpeced rades in period, hus, he equaions o be esimaed are formally given by: = δ δ δ δ UT 0, T 1, T GN 2, T BN 3, T. R u, UT ˆ UT = T -E( T /φ -1 ) ; E( T /φ -1 )=ARMA(p,q) (8) = δ δ δ δ UTS 0, S 1, SGN 2, S BN 3, S. R u, UTS UTS = ˆ TS -E( TS /φ -1 ) ; E( TS /φ -1 )=ARMA(p,q) (9) The null hypohesis H4a: δ1t=δ2t=0 indicaes ha he number of unexpeced rades is no relaed o news. Similarly, he null hypohesis H4b: average size of unexpeced rades is no relaed o informaion. δ1s=δ2s=0 indicaes ha he 9
In parallel wih he approach used o explore news effecs, we also analysed he impac of divergence of opinion on he number and average size of rades. Thus he models o be analysed for each of hese variables ake he following form: = ω ω ω ˆ UT 0, T 1, T DO 2, T R u, UTD UT = T -E( T /φ -1 ) ; E( T /φ -1 )=ARMA(p,q) (10) = ω ω ω ˆ UTS 0, S 1, S DO 2, S R u, UTSD UTS = TS -E( TS /φ -1 ) ; E( TS /φ -1 )=ARMA(p,q) (11) Finally, he null hypohesis H5a: ϖ1t=0 indicaes ha he number of unexpeced rades is no relaed o he divergence of opinion and he null hypohesis H5b: ϖ1s=0 indicaes ha neiher is he average size of unexpeced rades relaed o he divergence of opinion. 4-The daabase and variables for informed rading We employed wo daabases, one for each of he insrumens considered in he analysis, he Ibex-35 and Ibex-35 opions. The firs conained daily prices for he Ibex-35 index, which comprises he 35 mos liquid common socks raded on he Spanish Sock Exchange Inerconnecion Sysem (SIBE). Daily daa were used because of he need o mach prices o he daabase of daily news announcemens, which will be described laer. We also used inraday ransacion prices for opions on he Spanish IBEX-35 index, in order o obain daa on opions rading volume. These daa were supplied by MEFF, he Spanish Official Exchange for financial fuures and opions. I belongs o he holding Bolsas y Mercados Financieros. MEFF is fully regulaed, conrolled and supervised by he Spanish auhoriies ( Comisión Nacional del Mercado de Valores and Miniserio de Economía ). The opion on he Ibex-35 index is European and rading began in January 1992. To reduce he effec of opion expiraion, he opions used in he analysis have a leas five days o expiraion and in order o avoid sysemaic biases arising from he lack of liquidiy, opions wih more han 45 days o expiraion are also removed. This primarily involves opions a he firs expiry (which clearly accoun for he bulk of he rading volume in he Spanish opions marke), bu excluding ransacions made close o he expiry dae, which may have a significan impac on rading (for furher deails on his issue in he marke under analysis see Corredor e al 2001) hough none direcly relaing o he aims of his paper. The lieraure has proposed several differen measures for informed rading, including overall volume, posiive and negaive volume, and imbalance among ohers. To obain he las wo measures of informed rading on he opions marke i was necessary o idenify each ransacion as a purchase, when he ransacion was made a he ask price, or as a 10
sale, when i was made a he bid price. The rading sysem esablished by he MEFF allows for ready classificaion of each ransacion because all are made a he ask price or he bid price. This avoids he need o esablish he classificaion algorihms presened in oher research such as Lee and Ready (1991), Easley e al (1998) or Chan e al (2002) among ohers. The advanage of using his ype of classificaion as opposed o algorihms is ha we can be cerain which ype of ransacion has aken place and here is no need for assumpions. Bearing hese poins in mind, we considered all call and pu ransacions wih expiraion periods of 5 o 45 days indicaing in each case wheher he ransacion was a purchase or a sale. This gives us wo variables: posiive volume, vol (volume of calls purchased plus volume of pus sold on day ), and negaive volume, vol - (volume of calls sold plus volume of pus purchased on day ). The daily sum of he posiive and negaive volume gives us an addiional variable ha capures overall opions rading volume on a given day. In addiion o hese measures of rading volume, we calculae imbalance, which is a variable ha represens he difference beween posiive and negaive volume each day. Table 1 gives he descripive saisics for he volume daa analysed in our sample. Each able includes boh aggregae saisics and a separaion by ATM, OTM and ITM opions. ATM opions refer o S/K values (where S is he underlying asse price and K he srike price) in he range of 0.98-1.02. Call opions wih S/K values below 0.98 or pu opions above 1.02 are classed as OTM. Finally, pu opions wih S/K values below 0.98 or call opions above 1.02 are classed as ITM. I is ineresing o noe he differences in rading volume beween he various ypes of opion. Thus, ATM opions accoun for 62% of rading, OTM opions for 34%, and ITM opions for 4%. These percenages also hold for he number of ransacions. I is also worh noing ha ransacions are spli almos symmerically down he middle beween posiive volume and negaive volume. There is barely any difference in average rade size beween ATM and OTM opions, however, while ITM rades are roughly half he size on average. In addiion o hese wo daabases for socks raded on SIBE and securiies raded on he derivaives marke, we also have a daabase of news iems of economic significance aken from he economic press. These include news of poenial general ineres o invesors (for example, public announcemens of economic saisics, such as he unemploymen rae, he consumer price index, evens of economic significance or he predicion of major evens by praciioners and academics). This daabase conains a oal of 413 news iems published in he Spanish financial press. I has also been used in oher sudies on he impac of news on sock marke prices (see Blasco e al, 2002 and Blasco e al, 2005). Each news iem is classed as good or bad depending on he qualiaive assessmen suggesed in he financial press. We hink ha ex pos classificaion depending on he marke price change afer he 11
announcemen may induce misleading conclusions 12. Our approach gives us four poenial daily news scenarios: good news, bad news, mixed news or no news of ineres. We consruc wo dummy variables for he subsequen analysis. GN is a variable ha capures good news, i akes a value of 1 on days when good news is announced and 0 oherwise; BN is he variable ha capures bad news, i akes a value of 1 on bad announcemen days and 0 oherwise. Since he informaion we are analysing is in he form of financial press releases, iming is an imporan issue. I is worh menioning ha news included as explanaory variables corresponds o he news published in he nex day s press. The argumen underlying his choice is ha mos of he news published in he economic press on day 1 would have aken place during he inerval from he open of day o he close of day. The subscrip in he dummy variables for news indicaes ha such informaion is published by he financial newspaper on day 1 even hough i is available for informed agens on day because i is likely o reach he marke on day hrough many oher informaion servers. Since he informaional advanage is shor-lived, informed raders have no incenive o resric heir rading in order o have a larger informaional advanage on he nex day. As a consequence, i is reasonable o assume ha boh he acual breaking of he news and he informed rading should ake place prior o he public announcemen in he press. If his assumpion is correc, here should be significan correlaion, on he day prior o announcemen, beween he informaion series and oher proxies for public informaion variables 13. On announcemen day, meanwhile, since we are dealing wih daily daa, here should be no significan correlaion a all. This assumpion is esed by means of an ex-pos analysis, where he ime series of he index reurn is regressed on he proxies used o capure he presence of good or bad news on he marke. The resuls suppor he above argumen, since, when he reurn on day is regressed on o he news published on day (supposedly known on -1), he coefficiens are non-significan, and when i is regressed on o he nex day s published news (supposedly known on ) hey are significan and exhibi he expeced sign. These resuls suppor he use of he press release daabase as well as he suiabiliy of he definiion proposed for he ime subscrip of news variables. Finally, le us poin ou ha our analysis spans January 1997 o December 1998, a period chosen mainly because of he sabiliy of he rading sysems in he Spanish marke and he amoun of open derivaive conracs involving socks lised in he Ibex-35. 12 See Blasco e al (2002) or Blasco e al (2005) for furher deails on he daabase. 13 As a robusness check, he residual series of he index reurn (usually idenified wih unexpeced news) is regressed on he proxies used o capure he presence of good or bad news on he marke. The resuls suppor he above argumen, since, when he residuals of day are regressed on he news released on day, he coefficiens are non-significan, and when hey are regressed on he nex day s news (1) hey are significan and of he expeced sign. These resuls also validae he use of he press release daabase. This daabase is hough o be more useful o invesors han oher informaion proxies (such as residuals) which are no known unil close of rading. 12
5-Empirical resuls 5.1.1-Underlying asse prices and opions rading volume. The firs sep consiss of analysing he relaionship beween opion rading volume and asse price changes. The resuls for equaion 2 are given in he firs column of Table 2. As can be seen, he resuls of his firs analysis show ha aggregae volume is no saisically significan and, herefore, we can no rejec he null hypohesis H1: β2,s=0. This resul suggess ha aggregae opions rading volume is no a reliable measure of informed rading and, consequenly, has no effec on underlying asse prices. The key o his lack of significance probably lies in he fac ha his variable covers differen posiions, which may cancel each oher ou a he aggregae level. Easley e al (1998) argue ha hey do no expec o find overall opion volume o have predicive power. This is because opions are used for a wide variey of liquidiy-based purposes, and hese would generally involve using opions o follow movemens in he underlying sock. Moreover, because every opion rade has boh a wrier and a buyer, simply looking a overall volume essenially averages he buyer and seller ogeher. This makes i impossible o deermine he acive side of he rade, and so viiaes he resuls abou he informaion conen. These resuls lead o he analysis using posiive and negaive volume separaely. The resuls for equaion 3 are given in he second column of Table 2. As can be seen, he findings have changed considerably, now clearly poining o he presence of a conemporaneous relaionship beween he ype of volume and he impac on underlying asse prices (he null hypohesis H1: β2,s=0 is clearly rejeced). Thus, β2,2, which capures he effec of vol on underlying asse prices, appears posiive and significan; and β3,2, which capures he effec of vol - on he underlying asse, is negaive and significan. This suppors a conemporaneous relaionship beween he ype of volume and he sign of he impac on he underlying asse. In fac, posiive volume would appear o be associaed wih a price increase in he underlying asse while negaive volume would appear o be linked o a price decrease. As in Easley e al (1998), our resuls have shown asymmeric posiive and negaive effecs. In absolue erms, he effec of negaive opions rading volume is greaer han ha of posiive volume, which suggess ha opions markes may appeal o invesors seeking o ac on bad news. I is ofen argued ha he role of opions markes is o provide a means o overcome shor-sales consrains in spo markes, which is more prevalen in small markes such as he one ha concerns us, and can be circumvened hrough precisely he ype of ransacions ha make up negaive rading volume. We will aemp o highligh his possibiliy wih he following volume measure. In he case in which volume is capured by imbalance (IB) (see he hird column of Table 2) he resuls suppor hose obained via he second alernaive, while also adding some furher informaion. Noe ha his variable proves significan and posiive, which 13
means ha, when one volume is higher han he oher, reurns move in he expeced direcion. Thus, when he imbalance is posiive (in oher words, posiive volume is higher han negaive volume) prices rise and when he imbalance is negaive (negaive volume is higher han posiive volume) prices fall. These resuls suppor hose obained in he previous regressions. The se of resuls presened here allows us o rejec he null H1 hypohesis of absence of impac of opions rading volume on heir underlying asses in favour of a clear conemporaneous relaionship beween hem, which is observed when using disaggregaed posiive and negaive volume and also when considering imbalance. This relaionship only fails o emerge when informed rading is proxied by aggregae volume. Thus, in he case of he Spanish marke, analysis of he relaionship beween poenially informed rading volume and news should focus on hese measures. 5.2-Opions volume and informaion 5.2.1 Opions volume and response o news I should be sressed, however, ha he resuls obained in he previous secion are consisen no only wih he fac ha opions rading volume may reflec an informaion effec bu also wih he fac ha i may be due o ransacions made for liquidiy/hedging purposes involving he derivaive and is underlying asse. To invesigae his issue, in his secion we perform a direc es of he influence of news releases as direc measures of informaion on posiive and negaive opions rading volume. This will enable us o draw some conclusions regarding his key issue. Table 3 gives he resuls of he regression 6, which is esimaed using he Newey and Wes variance and covariance marix. The resuls are very enlighening since he news impac is refleced only in he OTM opions rading volume. The H2: λ1=λ2=0 null hypohesis is no rejeced in ATM and ITM opions. I herefore appears ha rading volume in ATM and ITM opions may be linked o facors oher han news, such as liquidiy or lower ransacions coss, while invesors rading on news end o go for OTM opions. Furhermore, his impac is no evenly spread over posiive and negaive volume, since bad news is refleced in negaive volume only. The fac ha bad news has a sronger impac han good news is also highlighed in he aricle by Nofsinger and Prucyk (2003) who show moreover ha bad news, unlike good news, leads o high volailiy. These auhors find a 2-hour delay beween he announcemen and pos-announcemen volume increases. However, hey also observe ha abnormal rading volume is posiive and significan 30 minues before he bad-news announcemen, bu hey asser ha i is no relaed o informed rading because he behaviour of negaiverade volume is significanly lower han expeced before he announcemen. A similar resul is shown in good-news announcemens. Noneheless, hese auhors do no ake ino accoun he differen levels of opion moneyness in heir analysis and his characerisic is 14
very imporan for informed raders who, in deciding where o place heir rades, are no enirely indifferen o opion moneyness, degree of informaion asymmery, and opion liquidiy, and generae feedback relaions beween rades in ou-of-he-money (OTM) opions and he underlying equiies (see Chen, e al. 2005). Our findings for he relaionship beween negaive volume in his class of opion and bad news are consisen wih he argumen pu forward in Branger and Schlag (2005). Invesors showing a high level of loss aversion and a srong incenive o hedge agains naural disasers or sudden marke shocks are he main raders in his ype of produc based on OTM pu opions. An informed invesor of hese characerisics displays high sensiiviy o bad news, which explains he saisical significance of bad news in negaive rading volume in OTM opions. This argumen is also direcly linked o he presence of shor sales consrains, which are much higher in he marke ha concerns us han in larger markes such as ha of he US. As well as he relaionship beween volume and news, he lieraure has also repored lack of consensus among invesors o be posiively relaed o volume. Sudies such as Hong and Sein (2003) or Vega (2006), among ohers, provide examples of his. In he specific case of he opions marke, Driessen and Maenhou (2007) repor ha aversion o loss or o uncerainy, which are refleced in invesors disagreemen or discrepancy, leads risk averse invesors, who would avoid rading in he shares marke only, o hold significan posiions in derivaives and, more specifically, shor posiions in OTM pu opions and ATM sraddles when hese are available 14. The resuls of esing he explanaory power of divergence of opinion (DO), hypohesis 3, (see Table 4) reveal ha negaive opions rading volume is no explained by he disgreemen variable in any of he hree ypes of opion considered, whereas posiive volume in OTM opions is. The resuls for he remaining ATM and ITM opions show ha rading volume in hese asses is unaffeced by discrepancy among invesors faced simulaneously wih good and bad news and he poenial impac of his on marke performance. Therefore, hypohesis 3 (γ1=0) is only rejeced in he case of OTM opions. These resuls are revealing because in imes of disagreemen, risk averse agens end o ake significan shor posiions in OTM pus, ha is, in one of he componens of posiive volume. Apparenly, herefore, posiive rading volume in OTM opions is indeed relaed o news, alhough indirecly by means of he lack of consensus among invesors abou he marke reacion o simulaneous good and bad news, raher han by good news in iself. Our resuls sugges ha i is a highly complex mechanism ha moves informed invesors o rade in he opions marke. Thus, he simple relaionship repored in he lieraure linking posiive volume o good news and negaive volume o bad news is in fac no ha sraighforward. In fac, we have found greaer informaion conen in OTM 15
opions, where negaive volume is indeed direcly relaed o bad news. Posiive volume, meanwhile, more closely reflecs lack of consensus among invesors as o he final oucome of he news 15. Thus, i appears ha bad news on he marke is acceped as being accurae while good news is reaed wih more cauion. This asymmeric reacion o news is also described in oher papers (see Nofsinger and Prucyk, 2003 for he US opions marke or Blasco e al., 2002 and 2005 for he Spanish sock marke). 5.2.2 Componens of opions rading volume and response o news. In his secion we analyse wheher privae informaion increases he incenives for invesors o rade sraegically, by examining he componens of rading volume. Table 5 shows he impac of news on he number and average size of rades, broken down by ype of opion: ITM, ATM and OTM (equaions 8 and 9). In line wih he resuls presened earlier, in ITM opions, boh he number and average size of rades remain unexplained by news. This corroboraes he noion ha informed rading, when i occurs, has a negligible impac on his ype of opion. Furhermore, in line wih he heory advanced earlier, he impac of good news on OTM or ATM opions also lacks saisical significance. In he presence of bad news, however, here is a significan increase in he number of rades in boh hese ypes of opion. Specifically, bad news is followed by a 32% rise in he number of ATM opions raded and by a 59% rise in he number of OTM opions raded. Therefore, hypohesis 4a (δ1t=δ2t=0) is only rejeced for ATM and OTM opions. This provides clear evidence of he relaionship beween informed rading and he number of rades in hese opions. Leverage reasons, as indicaed earlier, explain he higher increase in OTM opions. Neverheless, due o heir higher liquidiy in his marke, ATM opions also appear o arac informed raders, especially hose rading on volailiy. This would explain he lack of any significan relaionship beween signed volumes (posiive and negaive volume) and news in his ype of opion. The fac ha hese bes can occur in eiher of he wo alernaives disperses he effec. The impac on average rade size in all ypes of opion is negaive bu i is only significan for OTM opions. In he case of ITM opions, his can be explained by he absence of any news effec on he volume or number of rades. For ATM he resuls are consisen wih he reasoning used in Barclay and Warner (1993) or Chakravary, (2001) where i is repored ha, in he presence of informed rading, he main effec will be an 14 Since sraddles are difficul o deec in he Spanish marke, we focus our aenion on he effecs of shor posiions in OTM opions. 15 Chen and Goodhar (1998) argue ha volume alone is unable o ell he full sory abou marke expecaions, because, if rading lacks informaion conen, an increase in demand (supply) may simply be offse by an increase in supply (demand) and leave opions prices unchanged. If, however, he increase in demand (supply) reflecs new informaion, opions dealers will adjus prices upwards (downwards). Repeiion of he exercise using moneary volume yields similar resuls. 16
increase in he number of medium-size rades ha may go unnoiced in he res of he rading paern 16. Therefore, hypohesis 4b (δ1s=δ2s=0) is only rejeced for OTM opions. Informed rading in OTM opions is largely explained by he fac ha hey offer higher leverage, which logically maximises reurns. The moivaion for he possible presence of informed rading in ATM opions is explained in he case of he Spanish opions marke by reasons of liquidiy. As already menioned, given ha here is no significan impac on signed opions volume, his finding appears o be consisen wih he idea of volailiy rading, which, as noed by Easley e al (1998) is more likely o occur in his ype of opion, hanks o heir higher liquidiy. The resuls for equaions 10 and 11 are given in Table 6. As can be seen, he effecs of invesor disagreemen, while less inense, are very similar o hose of news. In his case, here is a 24% rise in he number of rades in ATM opions and a 42% rise in he number of OTM opions raded, while no significan effec is found on ITM opions. Therefore, hypoheses 5a (ϖ1t=0) and 5b (ϖ1s=0) are only rejeced for ITM opions. The effecs on average rade size are considerably more moderae han in he presence of news, suggesing he absence in his case of any impac from sealh rading. In shor, he resuls obained reveal ha opions rading volume, especially in he case of OTM opions, carries significan informaion o he underlying asse marke, especially when driven by bad news, which invesors may be more ready o believe. This finding is backed up by he resuls obained for he number and average size of rades, which show some signs of sealh rading in hese cases. The presence of invesor disagreemen also generaes an increase in rading volume in hese opions, hough no o he degree caused by he presence of news. In ATM opions, however, here is no observable saisically significan impac on signed volume in opions (posiive or negaive) as a resul of bad news or invesor disagreemen. Neverheless, we find a significan increase in he number of rades in boh cases. This appears o be consisen wih he idea ha much of he informed rading in hese opions akes he form of volailiy rading. The impac of his on signed volume in opions will no be readily observable, since i does no necessarily manifes iself in he form of a price shif in one paricular direcion. Finally, i is worh noing some characerisics of our daabase. Since he exac momen a which he news was made public in he marke is unknown, our rading volume measures (posiive, negaive or imbalance) add rading volume values before and afer he news release and herefore can be considered noisy measures of informed rading. Alhough hey may possibly incorporae oher rading causes (such as exploiing he underreacion o news announcemens, irraional momenum rading,...), we hink ha hese variables are 16 Unforunaely, we do no know wheher rades are iniiaed by insiuions or by individuals. Chakravary (2001) shows ha he roo of sealh-rading lies in rades by insiuions. 17
neverheless useful proxies for informed rading. On he one hand, he significan resuls are found mainly in he OTM opions ha presumably exhibi he bes condiions for promoing informed rading. On he oher hand, we also find evidence of inenional and sraegic sealh rading since he number of ransacions significanly increases while he average size of ransacions decreases. None of hese resuls is easily explained by reasons oher han informed rading. 6-Conclusions In his aricle we have linked proxies for informed rading in he opions marke o exogenous news variables. Our aim was o es direcly for he presence or absence of informed rading in he opions marke and o deermine wheher such rading has any price impac on he underlying sock index. In line wih he seminal work by Nofsinger and Prucyk (2003) relaing opions rading volume o scheduled news, we have ried o explore he relaionship beween opions volume and informaion by inroducing facors such as he degree of moneyness in opions and volume variables wih enough impac on he underlying asse price o allow hem o be used as proxies for he presence of informed rading. We have used all of he news iems appearing in he financial press, mos of which involve nonscheduled news. The analysis is performed in a much smaller marke, wih higher shor sales consrains han he US marke analysed by he cied auhors, hus giving a complemenary view of he phenomenon under research. Finally, he role of divergence of opinion deriving from he simulaneous presence of good and bad news a a given momen in ime has also been considered. The resuls have proved revealing. In parial coincidence wih he argumens presened in he lieraure, poenial informed rading is concenraed mainly in he highes leverage opions (OTM). An excepion o his is found in volailiy rading, where invesors mainly selec ATM opions for liquidiy purposes. In boh cases, he presence of informed rading is accompanied by sealh rading sraegies, in which invesors ry o conceal heir privae informaion hrough he fragmenaion of heir ransacions, hus causing an increase in he number of medium-size rades. Divergence of opinion drives growh in rading volume, alhough his is concenraed mainly in OTM opions. In such cases, he increase in he number of ransacions, while relevan, is considerably lower ha in he unequivocable presence of news. Is impac goes even more unnoiced when he focus is on average rade size. These resuls sugges he need for furher analysis of issues such as he impac of sock opions rading on heir respecive underlying asses in he presence of specific firm news and research o deermine how far some of hese phenomena may differ. This sudy may also help o deermine wheher here are any furher facors, such as specific ypes of firms or news, ha migh help o explain he complex relaionships beween informed rading volume, news and sock prices. 18
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