Marko Savor

Tick Size, Microstructure Noise, Informed Trading and Volatility Inversion Effects on Price Discovery in Option Markets: Theory and Empirical Evidence

We document both theoretically and empirically a major dependence in both the Information Shares (IS) and Component Shares (CS) approaches to the estimation of the price discovery metrics on the errors arising out of the inversion method of the option value to find the implied stock price, as well as on the statistical technique used to estimate these metrics. We then introduce accurate inversion methods that result in a major increase in the information shares of option markets for both IS and CS metrics compared to the dominant Lagged Implied Volatility inversion method. We apply these insights by examining the impact of the tick size reduction introduced by the CBOE in 2007 in its second pilot program on the simultaneous price discovery process in the markets for options and their underlying securities. In all cases we document a major impact of the tick size reduction in the option market that increases the option market information shares for all metrics, all statistical techniques used for their estimation, and all inversion methods. In addition, we document systematic differences in option market information shares between equities and exchange traded funds both before and after the tick size change, and we present strong event-type empirical evidence of informed trading in the equity option market after the tick size change, with extreme values of the IS and CS metrics in that market producing similar abnormal underlying asset returns.

Tick Size Reduction and Price Discovery in Option Markets: An Empirical Investigation

We examine the impact of the tick size reduction introduced by the CBOE in 2007 in its second pilot program on the simultaneous price discovery process in the markets for options and their underlying securities. We first document a major dependence in both the Information Shares (IS) and Component Shares (CS) approaches to the estimation of the price discovery metrics on the inversion method of the option value to find the implied stock price. We then introduce a more accurate inversion method that results in a major increase in the information shares of option markets for both IS and CS metrics compared to the dominant Lagged Implied Volatility (LIV) inversion method. In all cases, however, we document a major impact of the tick size reduction in the option market that increases the option market information shares for all metrics and all inversion methods.

Tick Size, Microstructure Noise and Volatility Inversion Effects on Price Discovery in Option Markets: Theory and Empirical Evidence

We document both theoretically and empirically a major dependence in both the Information Shares (IS) and Component Shares (CS) approaches to the estimation of the price discovery metrics on the errors arising out of the inversion method of the option value to find the implied stock price. We then introduce accurate inversion methods that result in a major increase in the information shares of option markets for both IS and CS metrics compared to the dominant Lagged Implied Volatility (LIV) inversion method. We apply these insights by examining the impact of the tick size reduction introduced by the CBOE in 2007 in its second pilot program on the simultaneous price discovery process in the markets for options and their underlying securities. In all cases we document a major impact of the tick size reduction in the option market that increases the option market information shares for all metrics and all inversion methods.

One Security, Four Markets: Canada-US Cross-Listed Options and Underlying Equities

In this paper we examine the relative contributions of US and Canadian markets to price discovery for Canadian cross-listed options and their cross-listed underlying stocks. We use two different econometric approaches in assessing the contributions of each market to price discovery, the information shares approach and the common factor approach. Our empirical results are consistent in both approaches. We show that on average price discovery for cross-listed Canadian stocks and options takes place overwhelmingly in the underlying asset markets, where Canadian equity markets dominate the discovery process. The results show that option markets information shares remain comparable, although slightly higher in the US, which contrasts with the fact that its relative volume is almost ten times greater than that of Canadian options markets. The results also indicate a high degree of integration between Canadian and US markets for the underlying stocks of cross-listed options and show that the foreign exchange market does not contribute to the co integration between these markets to any significant extent. An analysis of the determinants of the relative information shares between firms with all markets analyzed simultaneously shows that the most important factor explaining the information shares is the volatility of underlying returns.

PIP Transactions, Price Improvement, Informed Trades and Order Execution Quality

This study focuses on innovations in order execution processes within the context of the Boston Option Exchange (BOX). More specifically, it examines the impact of the Price Improvement Process (PIP) on options quoted, effective and realised proportional spreads. We consider the PIP as a mechanism that allows the market maker to ‘internalise’ the transaction. We show that PIP transactions are associated with wider bid/ask proportional quoted spreads than non-PIP transactions, in spite of the temporary narrowing of the effective proportional spread during PIP. We identify informed traders by focusing on the direction of trade. Using an original data set, we show that PIP transactions follow signals in the form of buy/sell orders by informed traders. We also show that PIP is a mechanism that allows the market maker to internalise a position in the same direction as that of the informed trader. We conclude that PIP does not improve the efficiency of the market but simply allows the market maker to benefit at the expense of uninformed traders.

CEO Stock and Option Holdings as a Determinant of Option Hedging by Gold Mining Firms

This paper seeks primarily to analyze CEO holdings of stocks and options in their firm as a determinant of the decision to hedge and the intensity of hedging with option-like securities in the gold mining industry. The findings show that CEO holdings play an important role in the choice and intensity of the use of option-like hedging instruments. In addition, results also show that the intensity of option-like instrument use for hedging is diminished when the CEO is also the chairman of the board. This original finding provides additional insight into the decision making process in this context. Moreover, our results show that when non-hedgeable quantity risk and hedgeable price risk are highly correlated, gold mining firms resort to operational hedging strategies through their production flexibility. Consistent with previous studies, our findings reveal that firm liquidity and profitability are positively related to both the use option-like instruments and the intensity of such use while cost structure and debt are positively related to use intensity. But contrary to previous findings, our results show that company sales are negatively related to the intensity of using option-like hedging instruments and investment opportunities are negatively related to the intensity of such use. Finally, investment opportunities as well as the high correlation between production levels and gold prices seem to have a negative impact on the decision to use option-like hedging in the gold mining industry.