Analysis of the clientele effect and the information content of short‐term index option returns in Taiwan

• DOI: http://doi.org/10.1002/fut.21910
• Published date: 01 June 2018
• Date: 01 June 2018
• Author: Yung‐Ming Shiu,Tu‐Cheng Wu,Ging‐Ginq Pan

Received: 25 April 2017

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Accepted: 20 January 2018

DOI: 10.1002/fut.21910

RESEARCH ARTICLE

Analysis of the clientele effect and the information content of

short-term index option returns in Taiwan

Ging-Ginq Pan

1

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Yung-Ming Shiu

2,3

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Tu-Cheng Wu

4

1

International Bachelor Degree Program in

Finance, National Pingtung University

Science and Technology, Neipu Hsiang,

Pingtung, Taiwan

2

Department of Risk Management and

Insurance, National Chengchi University,

Taipei, Taiwan

3

Risk and Insurance Research Center,

National Chengchi University, Taipei,

Taiwan

4

Department of Applied Mathematics,

I-Shou University, Kaohsiung County,

Taiwan

Correspondence

Yung-Ming Shiu, Department of Risk

Management and Insurance, National

Chengchi University, 64, Sec. 2, Zhi-Nan

Road, Wen-Shan District, Taipei, Taiwan.

Email: yungming@nccu.edu.tw

We compare and contrast the clientele effect, information content and the buy-and-

hold returns of options with weekly and monthly expiration periods (Weeklys and

Monthlys) traded on the Taiwan Stock Exchange Capitalization-weighted Stock

Index (TAIEX). No significant clientele effect is discernible in either market.

Furthermore, Weeklys has the wider bid-ask spread and lower depth clearly implies

greater information asymmetry than Monthlys. Unlike Weeklys, Monthlys are found

to play a leading informational role in TAIEX returns. We further observe that both

types of options have significantly negative returns.

KEYWORDS

investor sentiment, shortest-term options, weekly options

JEL CLASSIFICATION

G13

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INTRODUCTION

We set out in this study to compare and contrast the clientele effect, information content and return rates of TAIEX options with

weekly and monthly expiration periods (hereafter, Weeklys and Monthlys). In specific terms, we aim to determine any

differences between Weeklys and Monthlys in terms of the participants, volume patterns, price discovery, and return rates. The

shortest-term options referred to in this study are those contracts with 1 week or less to maturity. The Taiwan Futures Exchange

(TAIFEX) launched monthly TAIEX options in December 2001, with the underlying assets being provided by the Taiwan Stock

Exchange (TWSE) Capitalization-weighted Stock Index. Weekly TAIEX options were subsequently launched in

November 2012 for the purpose of accommodating the needs of the shortest-term traders.

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TAIEX options are traded as European-style options based upon expiration months (the spot month, the next two calendar

months and the next 2 quarterly months), with the last trading Day for these Monthlys being the third Wednesday of the

expiration month. Weeklys on the TAIEX, which have a shelf life of just 1 week, are newly issued each Wednesday and expire on

the subsequent Wednesday (with the exception of the third Wednesday). As the expiration Day approaches, Monthlys with

1 week or less to maturity are virtually the same as Weeklys: thus, there are no new issues of Weeklys on the second Wednesday

of the month.

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According to 2008–2012 statistics compiled by the Taiwan Futures Exchange (TAIFEX), the average daily trading volume for nearest-month options

during the last week prior to expiration was about 1.37 times the average during all preceding weeks, thereby clearly indicating that investors have a

preference for trading in options contracts with 1 week or less to maturity.

J Futures Markets. 2018;38:715–730. wileyonlinelibrary.com/journal/fut © 2018 Wiley Periodicals, Inc.

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According to the World Federation of Exchanges (2015), in terms of their trading volume (notional value), TAIEX options

were ranked the sixth (seventh) most frequently traded index options in the world in 2014. It is also important to note that after the

introduction of Weeklys, the trading volume in TAIEX options increased from 108.46 million contracts in 2012, to 191.51

million contracts in 2015, and indeed, according to a 2015 TAIFEX news release, TAIEX Weeklys had risen to first place on a

global scale, in terms of trading volume.

As our empirical results show, the implied volatility levels of the shortest-term options are more unstable than those of

options with a minimum of 1 week to maturity. Although options contracts with 1 week or less to maturity have been excluded

from the samples in many of the prior related studies, these contracts were not removed from our sample.

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The dataset examined

in this study reveals that during the 2013–2015 period, trading volume in TAIEX options reached 452.5 million contracts, of

which Weeklys and Monthlys with 1 week or less to maturity accounted for 289.8 million (64.05% of the total).

S&P 500 index options with 1 week or less to maturity accounted for about 12% of the total trading volume in S&P 500 index

options in 2010: however, this had increased steadily to 25% by 2014 (Andersen, Fusari, & Todorov, 2015). Given the high

proportions of the shortest-term options in both the US and Taiwan markets, this clearly highlights the importance of carrying our

research into Weeklys, and indeed, also suggests that the exclusion from a study sample of all shortest-term options may well

result in the loss of important market information.

From a comparison between the participants in Weeklys and Monthlys on the S&P 500 index, Chatrath, Christie-David,

Miao, and Ramchander (2015) found that Weeklys had smaller trade sizes than Monthlys, but higher implied volatility: their

results therefore inferred that Weeklys were mainly traded for speculative purposes, thereby leading to an increasingly

segmented options market over time. Yan and Zhang (2009) had previously suggested that short-term investors were generally

better informed than long-term investors, and as such, investors in possession of superior information would tend to trade more

frequently than those who were not engaging in trading to exploit an informational advantage.

Based upon their further comparison of the information content of Weeklys and Monthlys, Chatrath et al. (2015) provided

evidence to show that Weeklys contributed more to price discovery than Monthlys. However, they also noted that short-term

investors in options may simple be “noisy”traders, since they are generally thought to be overconfident investors who tend to

make less-informed investment decisions and overreact to both good and bad market news. If this really is the case, then the

contribution to price discovery made by Weeklys should be found to be inferior to that made by Monthlys.

To the best of our knowledge, with the one recent exception of Pan, Shiu, and Wu (2016), no other prior related study has yet

examined and compared the returns on Weeklys and Monthlys. In the Pan et al. (2016) study, the returns on index options were

generally found to be negative, probably because the primary motives for trading in options were either for speculative purposes

(Lakonishok, Pearson, & Poteshman, 2007) or gambling/entertainment (Bauer, Cosemans, & Eichholtz, 2009). Pan et al. (2016)

provided further evidence to show that investment in Weekly calls (puts) was superior (inferior) to similar investment in Monthly

calls (puts).

Our results show that Weeklys tend to exhibit smaller trade size and lower implied volatility levels than Monthlys, while the

relative bid-ask spread (depth) is found to be wider (lower) for Weeklys, as compared to Monthlys, thereby implying that

Weeklys suffer from greater information asymmetry. Furthermore Monthlys are found to play an informational leadership role in

TAIEX returns, a role which is not associated with Weeklys.

We also confirm the finding of Pan et al. (2016) that the shortest-term options are associated with negative returns: our study

extends the work carried out in the prior related studies and makes an important contribution to the literature on the shortest-term

options. As previously stated, although most options trades are found to involve the shortest-term options, these samples have

typically been excluded from almost all of the prior related studies. In the present study, we aim to fill the current gap in the

literature by comparing the clientele effect and information content of Weeklys and Monthlys on the TAIEX.

Although our study is closely connected to the work of Chatrath et al. (2015), a major difference between the two studies is

that the Chatrath et al. (2015) study used data on S&P 500 index options, whereas our study examines data relating to TAIEX

options. TAIEX Weeklys are European-style options with a shelf life of just 1 week: in contrast, Weeklys on the S&P 500 index

are European-style options, and while they also had a 1-week shelf life when they were first introduced in early 2010, longer shelf

lives were subsequently introduced in June 2012.

Despite this, in a majority of the tests in Chatrath et al. (2015), the data employed covered the period from January 2011 to

May 2012, a period when S&P 500 Weeklys still had a shelf life of just 1 week. This arguably makes our findings comparable

with the results of Chatrath et al. (2015): however, it is clearly worth pointing out that these two index options markets are

actually quite different, with the TAIEX being characterized by very high levels of individual participation (Pan et al., 2016).

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Examples include: Jiang and Tian (2005), Shiu, Pan, Lin and Wu (2010) and Pan, Shiu and Wu (2014, 2015).

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