Business Commons^™

Modeling Information Linkages In The Stock And Options Markets, K Ho, L Zheng, Zhaoyong Zhang

Research outputs 2011

When markets are assumed to be complete, option trading should not contain new information for market participants, as options derive their prices from the underlying stocks. However, if markets are incomplete, then this unidirectional relationship may not be true, because informed traders may prefer to trade options instead of the underlying stocks for several reasons: one, option trading involves lower transaction costs and higher financial leverage; and two, investors who have private information about stock price volatility can only make their bet on volatility in the option market. Compared with the research on the relationship between options trading activity and …