The purpose of this study is to investigate information transmission between ETF market and ETF option market. In order to examine the existence of momentum trading, the samples of ETF we extracted are SPY, QQQQ, and the DIA, analysed the lead/lag relationship with SPY option, QQQQ option, and the DIA option. In robustness test, we realize that momentum traders use option market to chase the spot market movement, in the mean while, causing the price reversal for future spot market. In long-term period, speculative activity by momentum traders becomes a stabilizing force.
The following this thesis is raised some results. First, in ETF option market, implied volatility for puts is higher than for calls. They all have the conspicuous volatility smiles curve as past ETF returns are positive. On the contrary, while past ETF returns are negative, puts market also has the apparent smiles curve, but calls is not clear or nonexistence. It suggested that puts are typically overpriced relative to calls and interpreted that the strategy of short put is easy to earn profits. The movement of volatility smiles curve shows that past ETF returns have the significant impact on volatility certainly.
Second, the results indicate that returns in the underlying market lead the movements in the options market. Prior 10 days to 200 days returns on SPY ETF have explanatory power (estimated 400 days by SUR model). Prior 10 days to 80 days returns on QQQQ ETF have explanatory power (estimated 120 days by SUR model). Prior 10 days to 150 days returns on SPY ETF have explanatory power (estimated 400 days by SUR model). In terms of QQQQ contracts, if we buy in the asset market over a 10- to 80-days period is associated with upward pressure on calls and downward pressure on puts. This positive pressure, triggered by long call and short put trades, increases the implied volatility for calls more than for puts, thus reducing the volatility spread at the end of the period. Conversely, the downward movement in the stock market creates negative pressure, increasing the volatility spread. This conclusion
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resembled DeLong et al. (1990), Tavakkol (2000), and Anin et al. (2004). Given the predictive ability of the volatility spread for spot market returns, this spread may be viewed as the barometer of investment sentiment.
Third, we compared the investment of ETF-type with the one of non-ETF-type. the option market of SPDR which is ETF-type is SPY option. the option market of S&P 500 is non-ETF-type is SPX. This research shows that the relationship is significantly negative between past ETF returns and volatility spread for SPDRs and SPY option. In contrast, for S&P 500 and SPX, all of the periods are not significant. Furthermore, for QQQQ option and DJX market, the robustness test is examined to resemble results. This study suggested that whether index are tradable or whether it can use the lowest cost to trade is the essential factor to control when investigating related studies of the option market and the spot market.
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