The directional information content of options volumes

• Author: Heejin Yang,Doojin Ryu
• DOI: http://doi.org/10.1002/fut.21960
• Published date: 01 December 2018
• Date: 01 December 2018

Received: 12 March 2018

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Revised: 27 June 2018

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Accepted: 1 July 2018

DOI: 10.1002/fut.21960

RESEARCH ARTICLE

The directional information content of options volumes

Doojin Ryu

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Heejin Yang

2

1

College of Economics, Sungkyunkwan

University, Seoul, Republic of Korea

2

School of Finance, College of Business

Administration, Soongsil University,

Seoul, Republic of Korea

Correspondence

Heejin Yang, School of Finance, College

of Business Administration, Soongsil

University, 369, Sangdo‐ro, Dongjak‐gu,

Seoul 06978, Republic of Korea.

Email: yhj427@ssu.ac.kr

Funding information

Samsung Research Fund, Sungkyunkwan

University, Grant/Award Number: 2018

Abstract

This study examines the directional information content realized by trades in a

highly liquid options market by constructing put–call volume ratios and

decoupled options‐to‐spot volume ratios. By investigating whether the specific

investor type predicts underlying returns and the method used to exploit a

directional information advantage, we find that foreign investment firms can

leverage their directional information by executing buy trades to open new

positions. Their open‐buy trades significantly predict next‐day spot returns,

whereas trades initiated by domestic firms do not. This relationship becomes

stronger for out‐of‐the‐money, large, and short‐horizon options trades and

during the short‐sale restriction period.

KEYWORDS

directional information, index options, investor type, market microstructure, options volume

JEL CLASSIFICATION

G13, G14, G15

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INTRODUCTION

The financial literature examines issues related to informed trading in both the equity and derivatives markets, and

many studies present empirical evidence for the predictive power of derivatives trading with respect to the price

dynamics of underlying assets. For example, some studies, such as An, Ang, Bali, and Cakici (2014), Blau, Nguyen, and

Whitby (2014), and Chung, Ryu, Wang, and Zykaj (2018), argue that options markets can attract informed traders

because the markets provide greater liquidity, higher leverage effects, and lower transaction costs, compared with

equity markets, and the options traders can be free from short‐sale constraints. These characteristics and properties of

options markets help informed investors to effectively implement their speculative and superior trading. As a result, the

options trades can carry significant information about their underlying asset markets. The information contents

conveyed by these informative trades are disseminated from options to stock markets (Chan, Ge, & Lin, 2015; Easley,

O’Hara, & Srinivas, 1998; Xing, Zhang, & Zhao, 2010).

As options trading becomes more hotly debated, recent studies examine issues related to informed trading and

investigate whether specific investor types exhibit superior performances in worldwide options markets. While most

studies of equity markets make rough associations between investors’stock market investment performances and their

private information, recent studies of options markets examine various aspects of derivatives trading and provide rich

implications for informed options trading by associating informed trading with market characteristics. In general,

options trading is free from short‐sale restrictions that hinder the adjustment of asset prices following negative

information.

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Thus, analyzing microstructure datasets of options markets can provide uncontaminated results.

J Futures Markets. 2018;38:1533–1548. wileyonlinelibrary.com/journal/fut © 2018 Wiley Periodicals, Inc.

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Equity markets, by contrast, often have short‐sale restrictions, so informed investors cannot exploit their informational advantages when they do not already own the stocks related to the negative

information. As a result, positive and negative information have asymmetric impacts, confounding the effects of informed trading.

Furthermore, the definition and properties of informed trading differ between index options markets and equity

markets to some extent. Equity traders are considered informed only when they acquire private or inside information

about individual companies, whereas index options traders can be considered informed when they are more skilled at

processing information in response to market‐wide and macroeconomic news or at interpreting public information

quickly and accurately (Ryu, 2011; Ryu & Yang, 2017; Yang, Lee, & Ryu, 2018). Information superiority tends to

disappear faster (i.e., be shorter‐lived) in index derivatives markets than in equity markets (Ryu, 2015; Webb, Ryu,

Ryu, & Han, 2016), in which traders tend to sustain superiority based on private information for a relatively long time.

Most importantly, studies of derivatives markets in emerging economies have a critical advantage in terms of the

information qualities of the datasets used.

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For instance, some emerging index options markets (e.g., the Taiwanese and

Korean options markets) provide high‐quality datasets that allow the tracking of submitted orders and investor types.

This type of data set can provide definitive answers as for which investors possess an information edge and which trades

have predictive power, neither of which can be answered through classical analyses using the limited information

provided by stock trading datasets. Because many studies of options markets suggest that options contracts can be used

to implement informed trading (Hao, 2016; Hu, 2014; Li, French, & Chen, 2017), there is a consensus that informed

investors trade options contracts to enjoy the leverage effect and lower transaction costs. Despite the overall agreement

as for the information role of options trading,

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however, more empirical work remains to identify which derivatives’

traders are better informed and exhibit superior performances, and to understand how these superior investors

implement informed trading in global options markets.

Recent studies of options markets argue that foreign investors typically possess superior information and that

domestic individual traders are the least informed. These studies find that foreign institutions outperform

domestic institutional and individual traders, especially in emerging options markets. In the Taiwanese options

market, Chang, Hsieh, and Lai (2009) and Lin, Tsai, Zheng, and Qiao (2017a) consistently report that domestic

individual investors exhibit relatively inferior informed trading. Hsieh and He (2014) investigate the ability of put–

call volume ratios to predict underlying spot returns and conclude that foreign institutions are informed traders in

the Taiwanese options market. Another series of studies examines the Korean options market, which also provides

high‐quality microstructure data. Ahn, Kang, and Ryu (2008) and Yang, Choi, and Ryu (2017) conclude that

foreign institutional investors have an information edge and that their orders and trades perform significantly

better than those of domestic investors. Sim, Ryu, and Yang (2016) claim that domestic individual derivatives

traders are noisy and behaviorally biased and demonstrate the inferiority of such investors in terms of informed

trading and sophistication.

However, some empirical studies of derivatives markets argue that domestic investors may perform better than

foreign investors do. Domestic investors have better access to local companies and familiar firms and, thus, may be

better informed than their foreign counterparts are. Erenburg, Kurov, and Lasser (2006) find that local futures traders

can respond to macroeconomic shocks faster than off‐exchange traders do, which indicates that domestic traders may

have an information edge. Chiu, Lee, and Wang (2014) examine the put–call volume ratios of domestic and foreign

institutional investors and find that the options trades of domestic institutions can significantly predict the Taiwanese

daily stock index. Furthermore, some microstructure studies find that domestic individual investors who submit large

orders have an information edge; these studies conclude that such domestic investors are professional and experienced

individual investors. For example, Kang and Ryu (2010) and Ryu (2012) find that trades initiated by large domestic

individual investors in the KOSPI 200 index derivatives markets perform well. These results indicate that although

small individual investors tend to be noisy, large individual investors are sophisticated traders armed with trading skills,

experience, wealth, and resources.

As demonstrated above, investigations of which investors in options and derivatives markets are more informed and

exhibit superior performances yield different answers depending on the markets and assets analyzed. These

inconsistent results may originate from the analyses on lower‐quality datasets, the rough classifications of the trading

activities used, and the use of crude informed volume measures. In this study, based on the detailed classifications that

consider the properties of each option transaction, we reexamine the directional information content of various options

2

Recently, market microstructure research in the context of emerging derivatives markets has received great attention. The derivatives markets in emerging economies are well documented and

surveyed by Atilgan, Demirtas, and Simsek (2016).

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Muravyev, Pearson, and Broussard (2013) and Muravyev (2016) are skeptical about the informative role of options trading. Gharghori, Maberly, and Nguyen (2017) argue that options trading cannot

predict the underlying stock returns of splitting firms. However, the majority of options market studies (especially in emerging options markets) provide clear evidence for informed trading in these

markets.

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