Option trading after the opening bell and intraday stock return predictability

Abstract

Prior literature finds that information is reflected in option markets before stock markets, but no study has explored whether option volume soon after market open has predictive power for intraday stock returns. Using novel intraday signed option‐to‐stock volume data, we find that a composite option trading score (OTS) in the first 30 min of market open predicts stock returns during the rest of the trading day. Such return predictability is greater for smaller stocks, stocks with higher idiosyncratic volatility, and stocks with higher bid–ask spreads relative to their options’ bid–ask spreads. Moreover, OTS is a significantly stronger predictor of intraday stock returns after overnight earnings announcements. The evidence suggests that option trading in the 30 min after the opening bell has predictive power for intraday stock returns.

Informed options trading around holidays

“…They conclude that liquidity traders are less willing to participate owing to the low market liquidity on volatile weekdays, whereas informed traders have greater incentives to trade on those days. Bergsma et al (2020) reveal that options market trading is most active immediately after the market opens and that this active trading at the beginning session of each trading day negatively impacts the intraday spot returns on the same trading day. Many relevant studies are introduced to address the trading anomalies around breaks in spot and derivatives markets (Amihud & Mendelson, 1987; Chong et al, 2005; Frino & Garcia, 2018; Meneu & Pardo, 2004).…”

Who and what drives informed options trading after the market opens?

“…Li et al (2017) show that adverse selection costs for S&P 500 index options sharply increase surrounding the 2008 global financial crisis, implying an increase in informed trading when volatility is high. Gao et al (2018) report that the predictive power of the first half-hour returns is stronger when return volatility is high, and Bergsma et al (2020) report that their OTS measure predicts future returns better for the stocks with higher idiosyncratic volatility.…”

“…The predictive ability of option order imbalances in the early trading hour is rarely studied. To the best of our knowledge, the work of Bergsma et al (2020) is the only study to find the predictability. They form a composite options trading score measure (OTS) derived from option order imbalances over stock volumes and show that the first halfhour OTS from individual equity options predicts stock returns during the remainder of the day.…”

“…Considering that private information seems less relevant to the whole market relative to individual stocks, the result of this study on individual stock options cannot guarantee the same for index options. For index options, the factors that can affect the quality and quantity of market information are more important than the cross-sectional differences among individual stocks that Bergsma et al (2020) address. Market information is multidimensional and sometimes difficult to digest; hence, it can create an information gap among investors even though it is not "private information."…”

“…Previous studies on the return predictability from trading in early hours have been silent about who these informed traders are, although suggestive evidence has been provided. Bergsma et al (2020) reveal that the predictive power of at-the-money (ATM) or on-the-money (OTM) options is greater than that of in-the-money (ITM) options, and that the OTS of small transactions is more informative than that of large transactions. However, these facts do not mean that small investors play a key role in informed trading right after the options market opening.…”