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| Option-implied Information and Price Discovery: Evidence from Chinese Options Markets |
| MA Teng, ZHANG Xiaoyan, LI Zhiyong
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| PBC School of Finance, Tsinghua University; International Business School, Beijing Foreign Studies University |
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Abstract The options market, as an important part of the capital market, promotes price discovery and risk sharing, reduces transaction costs and improves resource allocation efficiency. Since the launch of the first on-exchange option, the SSE 50 ETF option, in 2015, the trading volumes of on-exchange options have continued to grow. Meanwhile, the information transmission efficiency of financial markets is a core issue in financial economics. Well-informed investors predominantly trade in the options market due to this market's high leverage and low short-selling costs, which may lead to delays in the transmission of information between different markets. With the rapid development of China's financial options market, accurately assessing its price discovery role in the overall capital market is crucial to improving market functions and understanding market operating mechanisms.
To examine the price discovery role of China's options market, this paper constructs indicators to extract the implicit information in option transactions and tests the ability of the option-implied information to predict future returns on the stock market. First, we provide evidence that the volatility index, jump factor, and option parity formula deviation can significantly predict negative excess returns on the stock market in the next month, while those excess returns are positively and significantly predicted by the variance risk premium, volatility skewness, and difference in implied volatility changes between call and put options, among other indicators. Second, in an out-of-sample test, all the above indicators retain their predictive ability to a certain extent, and all the option-implied information indicators show significant predictive power in a linear regression model and principal component regression model. Finally, we test two hypotheses regarding the economic mechanism of price discovery in the options market: the information hypothesis and the short-selling restriction hypothesis. According to the information hypothesis, option-implied information can significantly predict the future trends of macroeconomic variables; at the same time, some option-implied indicators can also significantly predict future firm earnings information in the stock market. According to the short-selling restriction hypothesis, when the stock market faces short-selling restrictions or the cost of short-selling increases, investors with private information will be more inclined to trade in the options market, which will increase the speculative effect of this market, in turn affecting the predictive power of the option-implied information.
We contribute to the literature in three respects. First, focusing systematically on option-implied information, we assemble a series of option indicators whose ability to obtain the information contained in option trading is widely discussed in the literature. Based on the development status of China's options market, this study scientifically and rigorously explores the price discovery role of China's options market, thus filling gaps in the research on this market. Second, this paper confirms that information transmission affects price discovery in the Chinese stock market. New information tends to first enter the options market before entering the stock market, causing a time delay in information transmission between the two markets, allowing the options market to effectively predict the future price of the stock market. In terms of information content, this study also confirms that the options market contains macroeconomic and firm earnings information in advance of the stock market acquiring this information. Finally, the study enriches research on the spillover effects of capital market regulatory policies. A series of short-selling restrictions, such as stock index futures trading policies and stock market futures discount rates, can also be expected to affect the predictive power of option-implied information.
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Received: 31 August 2023
Published: 17 July 2024
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