Options Trading and the Bid-Ask Spread of the Underlying Stocks

Abstract

This study shows that options listing significantly affects the spreads on the underlying stock. The authors identify a trade-off between the benefits of increased liquidity and the cost of informational externalities. Highly liquid stocks tend to have spread increases, while illiquid stocks experience spread decreases. The effect occurs in concert with nonlisting volatility changes. The spread changes do not appear to be caused by shifts in liquidity between the stock and options market. Often, spread changes are large enough to affect significantly the cost of equity capital. Copyright 1992 by University of Chicago Press.