options volumes as trading strategy
A nice bit on NYT talks of options volumes foretelling stock price trends:
A new study has found that a portfolio based on the preferences of options traders has consistently beaten the overall stock market. In reaching that conclusion, the study paves the way for what may be a very profitable stock-picking strategy.
The study, “The Information in Option Volume for Future Stock Prices,” appears in the fall 2006 issue of the Review of Financial Studies. Its authors are two associate professors of finance: Jun Pan of the Sloan School of Management at the Massachusetts Institute of Technology and Allen M. Poteshman of the University of Illinois at Urbana-Champaign.
Using a private database provided by the Chicago Board Options Exchange, the two professors were able to deconstruct an option’s total trading volume into various categories. They excluded trades by market makers, for example — dealers at the options exchange who buy and sell securities for the general purpose of maintaining liquidity. They narrowed the database further to focus on just that portion of an option’s daily trading volume that reflected new positions by other traders, on the assumption that these transactions offered a clearer signal of what traders actually thought of the underlying stock. The database covered the dozen years from the beginning of 1990 through the end of 2001.
For each option in this database, the professors calculated a daily volume ratio of newly acquired put options to newly acquired call options. A high ratio meant a strong consensus among options traders that the price of the option’s underlying stock would fall, while a low ratio showed a widely shared expectation that the stock would rise. The professors found that the stocks whose options had the lowest ratios consistently outperformed the stocks whose options had the highest ratios.
A new study has found that a portfolio based on the preferences of options traders has consistently beaten the overall stock market. In reaching that conclusion, the study paves the way for what may be a very profitable stock-picking strategy.
The study, “The Information in Option Volume for Future Stock Prices,” appears in the fall 2006 issue of the Review of Financial Studies. Its authors are two associate professors of finance: Jun Pan of the Sloan School of Management at the Massachusetts Institute of Technology and Allen M. Poteshman of the University of Illinois at Urbana-Champaign.
Using a private database provided by the Chicago Board Options Exchange, the two professors were able to deconstruct an option’s total trading volume into various categories. They excluded trades by market makers, for example — dealers at the options exchange who buy and sell securities for the general purpose of maintaining liquidity. They narrowed the database further to focus on just that portion of an option’s daily trading volume that reflected new positions by other traders, on the assumption that these transactions offered a clearer signal of what traders actually thought of the underlying stock. The database covered the dozen years from the beginning of 1990 through the end of 2001.
For each option in this database, the professors calculated a daily volume ratio of newly acquired put options to newly acquired call options. A high ratio meant a strong consensus among options traders that the price of the option’s underlying stock would fall, while a low ratio showed a widely shared expectation that the stock would rise. The professors found that the stocks whose options had the lowest ratios consistently outperformed the stocks whose options had the highest ratios.
posted by g.e. at 11:50 PM
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