Do options quote movements anticipate those of underlying stocks? In other words, are options traders systematically more informed than stock traders? In their January 2011 paper entitled “Is There Price Discovery in Equity Options?”, Dmitriy Muravyev, Neil Pearson and John Paul Broussard test the lead-lag relationship between the bid-ask ranges of equity options and the actual bid-ask ranges of underlying stocks by comparing instances when the two markets disagree with instances when they do not. Disagreement means that the stock bid-ask range implied by the put-call parity relation does not overlap with the actual stock bid-ask range. This approach is more definitive than a simplification based on the midpoint of the bid-ask range. Using tick-by-tick trade and quote data for 36 liquid U.S. stocks and three exchange-traded funds (ETF) and options on them during April 17, 2003 through October 18, 2006 (107,000 instances of disagreement), they find that:
- While the typical bid-ask spread for the selected stocks is very small (one or two cents), the average spread implied by related options is around 15 cents.
- The actual and option-implied bid-ask quote ranges for a given stock disagree on average about five times per day, with disagreement persisting for only about 15 seconds.
- Disagreement instances are five times more likely to involve stock bid-ask range higher versus lower than the option-implied bid-ask range (perhaps due to the stock market trend during the sample period).
- Instances of disagreement derive predominantly from stock price movements. The options market then tends to adjust bid and ask quotes to eliminate disagreement, while the stock market behaves as if there were no disagreement.
The authors note that there may still be some situations in which options prices lead prices of the underlying stocks in anticipation of important corporate events or cases of high put-call ratios calculated from opening trades.
In summary, evidence indicates that stock price evolution generally leads associated option price evolution, not vice versa.
The study does not present any strategies for exploiting the leading relationship of stock bid and ask quotes over option bid and ask quotes. The small typical size and the short typical duration of disagreements are likely not exploitable by most traders. It seems reasonable to suppose that the recent acceleration of high-frequency trading is further compressing the size and duration disagreements.
