http://biz.korea.ac.kr/~inmoo [email protected] Korea University Korea University Investor Behavior in the Option Mar ket By By Lakonishok, Lee and Poteshman Lakonishok, Lee and Poteshman and and Presented by Presented by Inmoo Lee Inmoo Lee
Dec 20, 2015
http://biz.korea.ac.kr/[email protected]
Korea UniversityKorea University
Investor Behavior in the Option Market
ByBy Lakonishok, Lee and Poteshman Lakonishok, Lee and Poteshman
and and Presented byPresented byInmoo LeeInmoo Lee
Inmoo Lee
What do we do in this paper?What do we do in this paper?
Examine some basic facts about equity option markets using a comprehensive data of daily open interest and trading volume for Chicago Board Options Exchange listed options over the 1990 to 2001 period.
Examine different trading behavior of three different investor groups, firm-proprietary traders, full-service broker customers and discount broker customers.
Examine whether past returns affect trading behavior in equity options market. Are investors contrarian or trend chasers?
Examine whether trading behavior changes over the speculative bubble period in late 1990s and early 2000.
Inmoo Lee
Key FindingsKey Findings
Non-market maker investors have about four times more long call than long put open interestThese investors have more short than long open interest in both calls and putsEach type of investor purchases more calls to open new positions when the return on underlying stocks are higher over horizons ranging from one week to two years into the pastThe least sophisticated group of investors substantially increased their purchases of calls on growth but not value stocks during the stock market bubble of the late 1990s and early 2000None of the investor groups significantly increased their purchases of puts during the bubble period in order to overcome short sales constraints in the stock market
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CBOE DataCBOE Data
The CBOE provided this proprietary data.
The data cover option open interest and trading volume broken down by different types of investors.
The open interest data provide a daily record of closing short and long open interest for all CBOE listed options. The open interest data is inclusive of all exchanges at
which the option trades as far as it is traded at the CBOE.
The trading volume data consists of daily information of all trades that actually occurs at the CBOE. Open buy volume, open sell volume, close buy volume
and close sell volume.
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CBOE Equity Option Contract DetailsCBOE Equity Option Contract Details
Underlying:Generally, 100 shares of common stock or American Depository Receipts ("ADRs") of companies that are listed on securities exchanges or trade over-the-counter.Premium Quotation:Stated in points and fractions. One point equals $100. Minimum tick for options trading below 3 is .05 and for all other series, .10.Expiration Date:Saturday immediately following the third Friday of the expiration month.Exercise Style:American - Equity options generally may be exercised on any business day before the expiration date.Settlement of Option Exercise:Exercise notices properly tendered on any business day will result in delivery of the underlying stock on the third business day following exercise.
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Option Market Activity LevelsOption Market Activity Levels
Activity measures
S: underlying stock, t: trade date, k: kind of option, i: investor type i.
,,, , , ,
1,,
,
100
100.
Callss tN
k i Calls j t s j t
jk is t Shares
s t
OpenInterest
OpenInterestPercentageSharesN
,,, , , ,
1,,
,
100
100.
Callss tN
k i Calls j t s j t
jk is t Shares
s t
OptionVol
OptionVolPercentageSharesN
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Firm Proprietary InvestorsFirm Proprietary Investors
Investors trading for the bank’s own account.
Most sophisticated investors Poteshman and Servin (2003, JF) show that firm propri
etary traders never engage in irrational early exercise of stock options while the full-service and discount customers do so with some regularity.
Difficult to characterize since it is not uncommon for firm proprietary traders to place orders to facilitate the trades of their customers.
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Full-Service Customers vs. Discount CustomersFull-Service Customers vs. Discount Customers
Full-service customers are likely to be more sophisticated than discount customers. Most hedge funds trade through full-service brokerage houses Pan and Poteshman (2003, WP) find that full-service option trader
s have a greater propensity than discount option traders to open new long call (put) positions before stock price increases (decreases).
Mahani and Poteshman (2003, WP) shows that discount customers have a greater propensity for entering options positions that load up on growth stocks relative to value stocks in the days leading up to earnings announcements despite the fact that at earnings announcements value stocks outperform growth stocks by a wide margin (LaPorta, Lakonishok, Shleifer and Vishny, 1997, JF)
Barber, Odean and Zhu (2003, WP) show that the average value of accounts held by discount investors is less than half of the value of the full-service investors accounts.
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Table 1Table 1 Average Daily Open Interest as a Percentage of Shares Average Daily Open Interest as a Percentage of Shares
Outstanding, 1990-2001Outstanding, 1990-2001
Call OI > Put OI Full > Others For Full, Long
Call < Short Call Short Put >> Long
Put, especially for value stocks in Panels B and C
Underlying Stocks Long Call Long Put Short Call Short Put
All 0.041% 0.014% 0.030% 0.010%Large 0.042% 0.014% 0.031% 0.010%
Large Growth 0.044% 0.015% 0.032% 0.011%Large Value 0.039% 0.019% 0.041% 0.011%
All 0.032% 0.004% 0.025% 0.009%Large 0.031% 0.004% 0.023% 0.008%
Large Growth 0.039% 0.004% 0.027% 0.009%Large Value 0.032% 0.004% 0.024% 0.010%
All 0.130% 0.031% 0.195% 0.048%Large 0.126% 0.029% 0.191% 0.046%
Large Growth 0.134% 0.032% 0.211% 0.047%Large Value 0.159% 0.036% 0.190% 0.068%
Panel B: Discount Customers
Panel C: Full-Service Customers
Type of Open Interest
Panel A: Firm Proprietary Traders
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Long Call vs. Long PutLong Call vs. Long Put
It is easy to take long bets but difficult to take short positions, implying that long put might be traded more than long calls
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Long Call vs. Short CallLong Call vs. Short Call
Covered calls are heavily promoted by brokers as a conservative way to take a long position. Part of the cost of buying the stock is offset by the premium received from the sales of call options.
Prospect theory agents should prefer covered call positions to buying the stock alone. Why?
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Covered CallCovered Call
K1K2
-K1
Call
-K1+Call
STK1K2
Profit/Loss Profit/LossProfit/Loss
Buy Stock at K1 Sell Call with Strike Pr.= K2 > K1 Covered Call
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Prospect TheoryProspect Theory
Value
Losses Gaines
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Long Put vs. Short Put for Value StocksLong Put vs. Short Put for Value Stocks
If investors believe that shares are currently undervalued, it will be optimal to sell out-of-the-money put options. If price goes down further, option will be exercised
ending up with buying stocks at a price which is even lower than the current price. In addition, you will keep the put premium.
If you price goes up as expected, then you will take the premiums.
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Table 2Table 2Average Daily Open Volume as a Percentage of Shares OutstandingAverage Daily Open Volume as a Percentage of Shares Outstanding
Buy Call Volume > Sell Call Volume High turnover for short position?
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Table 2Table 2Average Turnover Time in Trade DatesAverage Turnover Time in Trade Dates
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Regression AnalysisRegression Analysis
To examine the factors related to option trading volume, we use a Fama-McBeth type regression analysis.Dependent variables Various option trading volume on each underlying stock on each tr
ade date for each investor class.Independent variables Rsameday = the same day return Rweek = the return from trade dates -1 through -5 Rmonth = the return from trade dates -6 through -21 Rquarter = the return from trade dates -22 through -63 Ryear = the return from trade dates -64 through -252 R2year = the return from trade dates -253 through -504 Ln(BM) Volatility of underlying stocks = annualized sample standard devia
tion of weekly log returns over the last 52 weeks excluding two most extreme values
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Table 3Table 3Large Stock Regression 1990-2001Large Stock Regression 1990-2001
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Table 3Table 3
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Trading Volume vs. Past Stock ReturnsTrading Volume vs. Past Stock Returns
Open buy call volume results suggest that discount and full-service customers appear to be trend-chasers.
The significant positive coefficients for all return variables for open sell call volume, especially for full-service customers, are consistent with the large covered call position held by full-service customers.
Open buy put volume tend to increase as the stock price increases.
Open short put volume decreases (increases) as the recent (more distant past) stock price increases. This is consistent with investors believing that weakness in an underlying stock in the past quarter is temporary.
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Option Market Activity During the BubbleOption Market Activity During the Bubble
Use regression analysis for subperiods to examine whether option trading behavior has changed over time.
S&P 500 Index
0
200
400
600
800
1000
1200
1400
1600
1800
199001
199101
199201
199301
199401
199501
199601
199701
199801
199901
200001
200101
Pre-bubble Beg-bubble Height-bubble Post-bubble
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Figure 2Figure 2
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Table 5Table 5Large Stock Average Daily Open Volume as a Percentage of Shares OutstandingLarge Stock Average Daily Open Volume as a Percentage of Shares Outstanding
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Option Market Activity Through TimeOption Market Activity Through Time
The least sophisticated discount investors in the market substantially increased their option market speculation that stock prices would rise throughout the bubble and then dramatically cut their option market bets that stock prices would increase after the bubble burst.By contrast, the full-service customer open buy call volume is more stable. Moreover, the bubble appears to be essentially a non-event for the firm proprietary traders.There is no major increase in open buy put volume, especially for full-service customers, during the bubble period. This casts doubt on the role of short sales constraints in
explaining the bubble (e.g., Ofek and Richardson (2003, JF)).
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Table 7Table 7Percentage Impact on Daily Open Buy Call Volume of One S.D. Percentage Impact on Daily Open Buy Call Volume of One S.D.
Shock to Independent VariablesShock to Independent Variables
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Value vs. GrowthValue vs. Growth
Examine whether option trading behaviors are different for underlying stocks with different characteristics.
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Table 9Table 9Large Growth Stock Average Daily Open Volume as a Percentage of Large Growth Stock Average Daily Open Volume as a Percentage of
Shares OutstandingShares Outstanding
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Table 9Table 9Large Value Stock Average Daily Open Volume as a Percentage of Large Value Stock Average Daily Open Volume as a Percentage of
Shares OutstandingShares Outstanding
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Value vs. GrowthValue vs. Growth
Discount customers became more trend chasing for growth stocks during the bubble but did not increase their activity in value stocks during the bubble.
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Table 10: Open Buy Call Volume – During the BubbleTable 10: Open Buy Call Volume – During the Bubble
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Table 11Table 11Percentage Impact on Daily Open Buy Call Volume of One S.D. Percentage Impact on Daily Open Buy Call Volume of One S.D.
Shock to Independent Variables – During the BubbleShock to Independent Variables – During the Bubble
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ConclusionConclusion
Show that equity option market activity is a reasonably large fraction of activity in the underlying assetsInvestors buy substantially more call options than put optionsInvestors have more short call open interest than long call open interest Prevalence of covered call positions
Strong positive relationship between the past returns on the underlying stock and the trading volume of call options. It appears that all three classes of investors were trend
chasing past returns at various horizons.
Inmoo Lee
ConclusionConclusion
The discount customer’s long call open interest substantially increased during the bull market, while that of other types of investors did not show such a dramatic change. The least sophisticated segment of the market took
positions based on optimistic sentiment during the height of the bubble.
For the growth stocks, the discount customers increased their long call open volume during the bubble period while other types of investors did not. For value stocks, there were no dramatic changes for all three types of investors.
Inmoo Lee
Future StudiesFuture Studies
Examination of equity option trading behavior around various corporate event dates and macro economic event dates. Is the equity option market used as a way to avoid short
sales constraints?
Relationship between arbitrage opportunities and option trading volume.