Informed Trading in Stock and Option Markets

TLDR

The study investigates how option markets contribute to price discovery by applying a modified Hasbrouck information‑share approach. The authors use this modified information‑share method to quantify the option market’s role in price discovery. The option market contributes about 17 % to price discovery on average, with its contribution linked to trading volume, spreads, volatility, leverage, and strike‑price dynamics, supporting the view that informed investors trade in both markets.

Abstract

ABSTRACT We investigate the contribution of option markets to price discovery, using a modification of Hasbrouck's (1995) “information share” approach. Based on five years of stock and options data for 60 firms, we estimate the option market's contribution to price discovery to be about 17% on average. Option market price discovery is related to trading volume and spreads in both markets, and stock volatility. Price discovery across option strike prices is related to leverage, trading volume, and spreads. Our results are consistent with theoretical arguments that informed investors trade in both stock and option markets, suggesting an important informational role for options.