Informed trading, trading strategies and the information content of trading volume: Evidence from the Taiwan index options market

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ContentslistsavailableatScienceDirect

Journal

of

International

Financial

Markets,

Institutions

&

Money

j o u r n a l h o m e p a g e :w w w . e l s e v i e r . c o m / l o c a t e / i n t f i n

Informed

trading,

trading

strategies

and

the

information

content

of

trading

volume:

Evidence

from

the

Taiwan

index

options

market

Wen-liang

G. Hsieh

∗

,

Huei-Ru

He

GraduateInstituteofFinance,NationalChiaoTungUniversity,1001UniversityRoad,HsinchuCity300, Taiwan,ROC

a

r

t

i

c

l

e

i

n

f

o

Articlehistory:

Received30May2013 Accepted27March2014 Availableonline5April2014 JELclassiﬁcation: G14 Keywords: Indexoptions Optionsvolume Informedtrading

Foreigninstitutionalinvestors Taiwan

a

b

s

t

r

a

c

t

Thispaperexaminesthepredictiveabilityofindexoption put-callvolumeonnext-dayindexmovementsintheTaiwanmarket. Wefindthatforeigninstitutionalinvestorsarethemostinformed traders,with theirpredictive abilitybeingmoreapparent in a downwardmarket.Whenengagingininformedtrading,foreign institutionalinvestorstend touseout-of-the-moneyoptionsto achievehighleverage,alongwithmedium-termoptionstoobtain largedeltaexposure andlow thetarisk,whilst also sacrificing liquiditybyforgoingtheuseofshort-termoptions.Thepredictive abilityofforeigninstitutionalinvestorsisfoundtobesignificantly enhancedondayswithimportantmacroeconomicnews,thereby indicatingtheirsuperiorinterpretativeabilityofpubliclyaccessible information.Basedupontheirlong-livedinformationaladvantage, foreigninstitutional investors willtend toengage in informed tradingusinglimitordersandmedium-sized tradesinorderto camouflagetheirinformation.

∗ Correspondingauthor.Tel.:+88635712121.

E-mailaddresses:wlh@faculty.nctu.edu.tw(W.-l.G.Hsieh),tina65762003@yahoo.com.tw(H.-R.He). http://dx.doi.org/10.1016/j.intﬁn.2014.03.012

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1. Introduction

Wesetoutinthisstudytoexaminetheinformationcontentoftradingvolume,withtheoverallaim

ofidentifyingthepatternsofindexoptionsusageininformedtrading.Theextantliteratureprovides

evidenceontheinformativenessofoptionstrading,withsomestudiesidentifyingwhichtradersarein

possessionofprivatetradinginformation.Inthepresentstudy,wegoonestepfurthertoexaminethe

varioustradingdecisionsfacedbyinvestorswhopossesssuperiorinformation,aswellasthetrading

strategiesthattheychoosetoadopt.Inspeciﬁcterms,weinvestigatethecontractsinwhichinformed

traderstendtotrade(in-the-moneyversusout-of-the-money),thetypeofordersthattheyusefor

theirtradingactivities(marketversuslimitorders,smallversuslargeorders),thetypeofinformation

thattheyarelikelytoexploit(macroversusmicro,globalversusdomestic)andthemarketconditions

underwhichtheychoosetotrade.

It hasbeensuggestedinseveralofthepriorstudiesthattheoptionsmarketsattractinformed

tradingessentiallybecauseinvestorscanbeneﬁtfromhighleverage(Black,1975),lowtransaction

costs(Flemingetal.,1996)andtheﬂexibilitytoengageinavarietyoftradingstrategiesthatare

unavailabletotheminthespotmarket.1_When_investors_choose_to_engage_in_informed_trading_within

theoptionsmarkets,thetradingprocessmaygeneraterichinformationcontentonfuturestockprices;

indeed,itiswelldocumentedthatthepricesofoptionsplayaleadingroleinpricediscovery,2_and

thattheyareevencapableofpredictingfuturepricemovements;3_thus,_our_focus_in_the_present_study

isontheinformationcontentofoptionstradingvolume.

Easleyetal.(1998)assertedthatobservedtransactionsplayanimportantroleinpricediscovery,

essentiallybecauseorderﬂowimbalancescanreﬂectthesignandmagnitudeofprivateinformation.

Theyproposedamodelwhichrevealedthatundercertaincircumstances,thesignedtradingvolume

ofoptionscontainedvaluableinformationonfutureequityprices.Caoetal.(2005)subsequently

wentontoprovidedirectevidenceofoptionsvolumeplayingastrongerinformationalroleduring

periodswheninformedtradingwasparticularlyintensive,withtheirﬁndingsrevealingthatduring

takeoverannouncementperiods,imbalancesincallvolumehadstrongpredictiveabilityonnext-day

stockreturns.PanandPoteshman(2006)furtherproposedthattheput-callratioofoptionstrading

volumeinitiatedbybuyersopeningnewpositionsshouldbetakenasaninformationvariable,since

thevolumeratiowasfoundtopredictstockreturnsforthenextﬁvedays,withbotheconomicand

statisticalsigniﬁcance.

Withineachoftheabovestudiesontheinformationalcontentofoptionstradingvolume,the

ten-dencyhasbeentofocusalmostexclusivelyonequityoptions,withmuchlessemphasisonindex

options.Asregardsoptionsonindividualstocks,itisalreadywellrecognizedthatcorporateinsiders

andproprietaryfirmtraders(i.e.,thosewhoareoftenfoundtopossessprivatefirm-specific

informa-tion),arelikelytoengageininformedtrading(CornellandSirri,1992;Harris,1993).However,with

regardtoindexoptions,itisfarlessclearwhichclassesoftraderpossesssuperiorinformation,and

indeed,exactlywheresuchinformationoriginatesfrom,essentiallybecauseitisunlikelythatany

investorwouldpossess‘private’informationattheaggregatemarketlevel.

However,Ahnetal.(2008)arguedthatsuperiorinformationprocessingskillsanddifferent

inter-pretationsofexactlythesamepublicinformationmaywellresultininformationasymmetry.They

notedthatforeigninstitutionalinvestorswerelikelytopossessaninformationaladvantageoverother

typesofinvestors,andindeed,theydemonstratedaparticularlylargeadverseselectioncomponent

inthebid-askspreadsinKOSPI200optionsforthosetradesthathadbeeninitiatedbysuchinvestors.

ChouandWang(2009)alsoidentiﬁedacleartendencyforstealthtradingamongstforeign

institu-tionalinvestorsandproprietaryﬁrmsintheindexfuturesmarketinTaiwan,aﬁndingwhichimplied

thatcertainclassesoftradersmaywellpossessinformationaladvantagesrelatingtotheaggregate

markettrend.Nevertheless,giventheabovefactors,allofwhichprovidesupportforthelikelihoodof

1_Options_trading_strategies_unavailable_to_spot_market_traders_include_volatility_trading_(Ni_et_al.,_2008),_spread_trading

(ChaputandEderington,2005)andunlimitedshortsales(FiglewskiandWebb,1993).

2_Examples_include_Fleming_et_al._(1996),_Easley_et_al.₍₁₉₉₈₎_and_Cao_et_al._(2005). 3_See_Chakravarty_et_al._(2004),_Pan_and_Poteshman₍₂₀₀₆₎_and_Chan_et_al._(2009).

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informedtradersusingindexoptions,thereissurprisinglylittledirectevidenceofinformationtrading

intheindexoptionsmarkets.

KangandPark(2008)reportednon-trivialinformationcontentfornetbuyingpressure(the

differ-encebetweenthenumberoftradesinitiatedbybuyersandsellers)inKOSPI200indexoptions,and

wentontosuggestthatthenetbuyingpressurecouldbeusedtopredictthenextﬁve-minutereturns

ontheindex.Chanetal.(2009)alsoexaminedoptionstradingbehaviorintheTaiwanindex,usingthe

valueoftheput-callratioasaninformationvariable,andfoundthatout-of-the-moneyoptionsledthe

stockindexbyupto90min.Furthermore,fromanexaminationofthepredictiveabilityoftheput-call

open-buyvolumeratiosonthenext-daymovementsintheTaiwanindex,Changetal.(2009)found

signiﬁcantpredictiveabilityforcertaintypesofoptionstradedbyforeigninstitutionalinvestors.4

Theempiricalevidenceprovidedbytherecentstudiesreferredtoabovethereforeseemstosuggest

thattradingvolumeplaysamuchmoreaggressiveinformationalroleinindexoptionsthanhad

pre-viouslybeensuggestedwithintheearlierstudies.5_The_present_study_can_be_viewed_as_an_extension

oftheChangetal.(2009)studyinwhichevidencewasfoundofpredictivepowerinTaiwanindex

optionsamongstforeigninstitutionalinvestors,particularlywithregardtotheirtradingpositionsin

near-the-moneyandmiddle-horizonoptions.

Ourprimaryaiminthepresentstudyistodeterminewhethertheinformationcontentinthe

optionstradingundertakenbyforeigninstitutionalinvestors isdependentuponmarketliquidity,

thedirectionoftheindexmovementsandtheimpactofmacroeconomicinformation,whilstalso

exploringthetypesoforders(marketversuslimitorders)andordersizethatarelikelytobeused

bysuchinvestorswhenengagingintheirinformedtrading.Asoundunderstandingofthesefactors

shouldhelpustodrawamorecompletepictureoftheinformationaladvantagespossessedbyforeign

institutionalinvestorsandthewaysinwhichtheyproﬁtfromtheirinformation.

TheempiricalmodeladoptedforthepresentstudyfollowsthemethodologyofPanandPoteshman

(2006)inwhichthepredictiveabilityofoptionsvolumewasinvestigatedbyregressingthe

next-dayindexreturnsontheoptionput-callvolumeratio.We beginbyclassifyingthevolumeofall

optionstradingattributabletofourclassesoftraders,namely,individualinvestors,marketmakers,

foreigninstitutionalinvestorsanddomesticinstitutionalinvestors,andthenexaminethepredictive

abilityoftheput-callvolumeratioonnext-dayindexreturnsforeachoftheseclassesoftraders.Our

resultsclearlyindicatethatthetradingvolumeprovidedbyforeigninstitutionalinvestorscontains

richinformationrelatingtofuturechangesintheindex,whereastransactionsbyotherclassesof

tradersarelargelyfoundtobeuninformative.

Thisﬁndingisgenerallyconsistentwiththeresultsreportedontheaggressiveinformationalrole

playedbyforeigninstitutionalinvestorsinmanyoftheemergingderivativemarkets.Forexample,the

analysiscarriedoutbyChangetal.(2009)onindexoptionstradinginTaiwanshowedthattradingby

foreigninstitutionalinvestorsexhibitedsigniﬁcantpredictivepowerontheunderlyingindexreturns.

SimilarﬁndingswerealsoprovidedbyKangandPark(2008),Ahnetal.(2008)andLeeandWang

(2012)withregardtotradinginKOSPI200indexoptions.

Wealsodiscoverstrongerpredictivepowerinthetradingpositionsofforeigninstitutionalinvestors

indownwardmarketsvis-à-visupwardmarkets.ThisisconsistentwiththesuggestionofJohnson

andSo(2012)thattheshort-salesconstraintsintheequitymarkettendtohindertransactionsbased

uponbearishinformation;thus,informedagentswilltradeinoptionsmorefrequentlyonnegative

signalsthanpositivesignalsinordertoovercometheshort-salesrestrictionsontheunderlyingasset.

AlthoughtheaboveargumentpresentedbyJohnsonandSo(2012)wasbaseduponequityoptions,

4_Several_other_studies_have_examined_{informational}_trading_in_index_options._For_example,_focusing_on_the_information

providedbysplitorders,KimandRyu(2012)demonstratedthatsuchorderssubmittedbyinstitutionalinvestorsgenerally tendedtobemoreinformative,whilstChangetal.(2013)examinedthepre-openingtradingofindexoptionsandshowedthat information-motivatedtraderstendedtoconstructtheirpositionspriortothestockmarketopening,particularlywhenthey possessedbearishinformation.

5_Schlag_and_Stoll₍₂₀₀₅₎_found_that_the_price_impact_of_options_volume_on_the_DAX_index_was_only_a_temporary_phenomenon,

therebyimplyingthepresenceofaliquidityeffectasopposedtoaninformationeffect.PanandPoteshman(2006)alsoshowed thatindexoptionstradingvolumecontainednoinformationonfutureindexmovements,whereasequityoptionstrading volumehadstronginformationcontentonfuturestockpricemovements.

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ourstudyprovidesevidenceofshort-salesconstraintshavingasimilareffectoninformedtradingin

indexoptions.

Ourresultsfurtherrevealthatwithimprovementsinoveralloptionstradingactivity(asmeasured

bytradingvolume),thetradingpositionsofforeigninstitutionalinvestorsprovideenhanced

predic-tivepower.Theﬁndingsuggeststhateitherinformedtradinginducesvolumeorthatinformedtraders

arecamouﬂagingtheirinformation-basedtradingthroughgreatervolume.Furtherevidence

consis-tentwithstealth-tradingtheoryisfoundwhenweanalyzesub-samplescategorizedbytradesizes,

withmedium-sizedtradescontainingricherinformationcontentonfuturechangesintheindex,as

comparedtoeitherlarge-orsmall-sizedtrades.

Asopposedtotradinginthemostliquidshort-termcontracts,foreigninstitutionalinvestorsprefer

toexploittheirinformationaladvantageusingmedium-maturityandout-of-the-moneyoptions.The

decisionsmadebyinformedtraderswithregardtocontractselectionsuggestthatsuchtradersare

willingtosacriﬁceliquidityforhighleverage,highdeltaandlowtheta.

Limitorderssubmittedbyforeigninstitutionalinvestorsarefoundtohavegreaterpredictiveability

onthenextdayindexvalue,relativetomarketorders.AccordingtoKanielandLiu(2006),informed

traderswilltendtochooselimitordersiftheyhaveasufﬁcientlylonginformationhorizon.Sinceit

isdifﬁcultforrivaltraderstocopysuchlong-livedinformation,informedtraderscanexecutetheir

tradingonsuchinformationusinglimitorders,whichmeansthattheyarepreparedtosacriﬁce

imme-diacyforalowerpriceimpact.Ourﬁndingsimplythatthesuperiorinformationpossessedbyforeign

institutionalinvestorsintheTaiwanoptionmarketsisalsolong-lived,perhapsderivedfromtheir

interpretationofpubliclyavailableinformation.Indeed,ourfurtheranalysisshowsthattheput-call

ratiosofforeigninstitutionalinvestorshavebetterpredictivepowerontheindexchangesondays

withimportantmacroeconomicnewsannouncements,ascomparedtodayswithnosigniﬁcantnews

announcements.

Finally,thepredictiveabilityofforeigninstitutionalinvestorsduring‘normal’tradingdaysisfound

tohavetotallydisappearedduringtheﬁnancialtsunamiperiod,evenonthosedayswhenimportant

macroeconomicnewswasannounced.Furtheranalysisshowsthat,althoughswitchingtomore

defen-sivepositions,foreigninstitutionsfailedtoanticipatethelargemarketdownturnthuswereunableto

synthesizeproﬁtableoptionpositionspriortoadversemarketimpacts.Resultsalsoindicatethattheir

diminishedpredictabilitywerelessattributabletocapitalconstraintsorhedgingneeds.

Theremainderofthispaperisorganizedasfollows.Anintroductiontothetradingmechanism

forTaiwanindexoptionsisprovidedinSection2,followedinSection3byadescriptionofthedata

adoptedforthisstudy.Thepredictiveregressionmodelusedtoexaminetheinformationcontentof

theoptionsvolumeratioispresentedinSection4,followedinSection5bythepresentationand

discussionofourempiricalresults.Finally,theconclusionsdrawnfromthisstudyarepresentedin

Section6.

2. Institutionalbackground

WeempiricallyexaminetheTaiwanindexoptions(TXO)tradedontheTaiwanFuturesExchange

(TAIFEX)inordertoanalyzethetradingdecisionsofinformedtraders.TXOcontractsareactivelytraded

onaglobalscale,andindeed,accordingtotheannualreportoftheWorldFederationofExchanges,of

allindexoptionslistedworldwide,tradingfrequencyinTXOcontractswasrankedasthefourth(ﬁfth)

largestintheworldin2007(2008).TheunderlyingspotindexoftheTXOistheTaiwanCapitalization

WeightedStockIndex(TWI),avalue-weightedindexcomprisingofvirtuallyallofthecommonstocks

listedontheTaiwanStockExchange(approximately700ﬁrms).

Atleastﬁveexpirationmonthsarelistedonanytradingday–includingthespotmonth,thenext

twocalendarmonthsandthenexttwoquartermonths(March,June,SeptemberandDecember)–with

awiderangeofstrikepricesbeingavailableforeachcontractmonth.6_During_our_sample_period,_the

6_During_our_sample_period,_the_Taiwan_Stock_index_level_ranged_between₇₀₀₀_and_9000._Within_this_range_the_strike_price

intervalis100indexpointsforthespotmonthandthenexttwocalendarmonths,whereasitis200indexpointsforthe additionaltwoquartermonths.

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notionalvalueofeachoptionwasapproximatelyNT$400,000(US$16,000),withthesmallercontract

sizeattractingalargenumberofretailtraders,whocontributeover50percentofalltradingvolume.

TheTAIFEXoperatesafullyelectronictradingsystemwheretraderscansubmiteithermarket

orlimitorders,withthelimitordersalsobeingeithermarketableornon-marketable.Theregular

tradinghoursarefrom8:45a.m.to1:45p.m.Allorderssubmittedbefore8:45a.m.areexecutedbya

callmethoduponmarketopening,withordersbeingcontinuouslymatchedduringtheregulartrading

session.Incomingordersareautomaticallymatchedagainstexistinglimitordersontheoppositeside

ofthebook,followingstrictpriceandtimepriorityrules.

TheExchangecoordinatesdesignatedmarketmakersforTXOtransactionsinordertoensure

mar-ketliquidity,withallmarketmakersbeingobligatedtooffertwo-way(bidandask)quotesupon

receiptofaquoteinquiryfromothermarketparticipants.Thequoteenteredintothesystembya

marketmakerisaﬁrmorder,whichwillentertheorderbooktocompetewithotherpublicorders

baseduponthesamepriceandtimepriorityrules.Afuturesproprietaryﬁrmcanapplytobeamarket

maker,whichenjoysdiscountsontransactionfeesifitsmarket-makingvolumeexceedsacertainlevel.

MarketmakersfailingtomeettheTAIFEXrequirementforliquidityprovisionwillbedisqualiﬁed.

TheTAIFEXdisclosesquotepricesanddepthsforthebestﬁvequotes,aswellastheresultsof

eachtradeexecuted(includingthetradepriceandvolume),withtheinformationbeingelectronically

disseminatedtothepublicinreal-time.Tradingisanonymousinthat,bothbeforeandafteratrade,

informationontheidentityofthosesubmittingordersandtheirtradecounterpartiesisunavailableto

thepublic.Afterthemarketclose,theTAIFEXpublishesitsdailytradingsummarystatistics,including

tradingvolumeinindividualcontracts,thevolumeofallfuturesproprietaryﬁrms,theput/callvolume

bytraderclassandthebuy/sellvolumebytraderclass.

3. Data

Tick-by-tickdataonTXOoptionswasobtainedfromtheTAIFEXfor372tradingdaysbetween2

January2007and30June2008.Thedatasetincludesthreeﬁlesonordersubmissions,tradeexecutions

andmarketmakerquotations.Theordersubmissionsﬁlerecordsthedate,time,traderID,abuy/sell

indicator,orderprice,ordersizeandthecontractcharacteristics(strikeprice,maturityandacall/put

indicator)foreverysubmittedorder.Thetradeexecutionsﬁlecontainsthetradeprice,volumeanda

keylinkingthetradebacktotheoriginalorderforeverymatchedtrade.

Bymatchingtheordersubmissionandtradeexecutionﬁles,weareabletoconstructthecomplete

historyofeverytransactionandidentifythetradersoneachsideofthetransactions.Thetraders

areclassiﬁedasdomesticindividualinvestors,domesticinstitutionalinvestors,foreigninstitutional

investorsormarketmakers,andareassignedauniqueID.Thedatasetalsoindicateswhetherthe

transactioninvolvestheopeningofanewpositionortheclosure(offsetting)ofanexistingposition.

Thedetailedclassiﬁcationofthedataallowsustoaggregatetheoptionsvolumeattributabletothe

differentclassesoftraders(individualinvestors,domesticinstitutionalinvestors,foreigninstitutional

investorsandmarketmakers),thecharacteristicsofthecontracts(put/call,strikepriceandmaturity),

thetypeoforders(marketversuslimitorders)andtradingpositions(buyversussell,openversus

offsetting).

Furthermore,weareabletoidentifyeachofthepartiesinamatchedtradewithouthavingtorelyon

theLeeandReady(1991)algorithm,whichhelpsustoclearlydistinguishbetweenthemotivesbehind

eachtransaction.Thisisextremelyusefulforourexaminationofthewaysinwhichtheinformation

isimpoundedintosecuritypricesthroughselectionoftiming,contract,order,tradingpositionand

tradingstrategybythevariousclassesoftraders.7

Sincethepresentstudyfocusesonthepredictiveabilityofdirectionaltrades,thosetransactions

involvingmultiplepositions(suchasspread,straddleandstrangletrades,allofwhicharelargely

non-directionalinnature)areexcludedfromoursample.TheTAIFEXdatasetdistinguishesbetween

7_The_data_is_collected,_processed_and_disseminated_{electronically}_by_the_TAIFEX._The_same_dataset_was_also_employed_by

Changetal.(2009),Hanetal.(2009)andChouandWang(2009)toexaminevariousissuesinoptions/futurestradingonthe Taiwanindexderivativesmarkets.

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Table1

Optionsvolume,bydifferentclassesoftradersandtradingpositions.

Variables Foreigninstitutions Marketmakers Domesticinstitutions Individualinvestors

PanelA:overalldistributionbytraderclasses

8.20 34.19 4.44 53.16

PanelB:distributionbycall/putandbuy/sell

Buycall 30.75 26.33 24.65 29.56

Sellcall 19.81 27.41 25.56 28.33

Buyput 30.44 23.01 25.66 20.66

Sellput 19.00 23.24 24.13 21.45

PanelC:distributionbyopen/closeandbuy/sell

Openbuy 55.62 21.82 24.69 33.48

Opensell 26.06 23.20 26.80 17.97

Closebuy 5.57 27.53 25.62 16.74

Closesell 12.75 27.45 22.89 31.81

Thistablereportsthedetailsofvolumedistributionwithinthefourclassesoftradersbetween2January2007and30June2008. ThedistributioninPanelAiscalculatedbydividingthetotaltradingvolumeforeachtraderclass(innumberofcontracts)by thevolumefortheoverallmarket,whilstthedistributionsinPanelsBandCarecalculatedbydividingthevolumeforeach categorybythevolumeofthecorrespondingclassoftraders.

plain-vanillaoption tradesandfourtypesofcombinationtrades,comprisingofstraddle,strangle, moneyspreadandcalendarspreadtrades.Thesecombinationtrades,whichaccountforlessthan2 percentofthetotaltradingrecords,aredulyexcludedfromouranalysis.

Asummaryoftradingvolume,bytraderclasses,buy/selltransactions,put/calloptionsandnewly openedpositionsversustheclosureofexistingpositions,isprovidedinTable1,withPanelAreporting

thedailytradingvolume(inpercentageterms)acrossthefourclassesoftradersandthetime-series

averagesover367tradingdays.Aswecanseefromthistable,tradingvolumedifferssigniﬁcantly

acrossthefourclassesoftraders,withindividualinvestorsbeingthemajorparticipantsintheTXO

market,accountingfor53.16percentofthetotalvolume.

Marketmakersarethesecondlargesttraderclass,accountingfor34.19percent,whilstforeign

institutionalinvestorsanddomesticinstitutionalinvestorsaretheleastactivetraders,respectively

accountingforonly8.20percentand4.44percent.Thepresenceofsuchlargenumbersofuninformed

retailtradersprovidesopportunitiesforothermoresophisticatedtraderstoexploittheirinformational

advantage.

Alltransactionswithineachclassoftradersarefurtherbrokendown,inPanelBofTable1,into

buy-call,sell-call,buy-putandsell-puttransactions,withtheproportionssummingverticallytounity

withineachtraderclass.Weﬁndthatforeigninstitutionalinvestorsholdsubstantiallylargerpositions

inlongcalls(30percent)thanshortcalls(20percent),whereasthelong-versusshort-callvolume

isfoundtobeevenlydistributedforotherclassesoftraders.Asimilarimbalanceisalsodiscerniblein

longputversusshortputvolumeforforeigninstitutionalinvestors,butnotfortheotherthreeclasses

oftraders.

Sincelongcalls(longputs)enjoygreaterpotentialproﬁtsthanshortputs(shortcalls)whenthe

underlyingindexmovesupward(downward),longpositionsaregenerallydeemedtobethemore

aggressivepositions (Panand Poteshman,2006).8 _The_{substantially} _larger_long_option _volume_in

thetradingaccountsofforeigninstitutionalinvestorsindicatesthatthesetraderstendtobemore

aggressivethanothertraders,intermsofdirectionaltrading.9

8_Pan_and_Poteshman₍₂₀₀₆₎_noted_that_the_predictive_ability_of_option_open-buy_volume_was_found_to_be_better_than_that_of

open-sellvolume,andindeed,theysuggestedthatinformationtradingwaslikelytobeimplementedusinglongcallsorputs, ratherthanshortputsorcalls.Thisisessentiallybecausetheworst-casescenarioinbuyinganoptionisthelossoftheoption premium,whereastheupsidegaincanbequitesubstantialiftheprivateinformationturnsouttobecorrect.Conversely,the best-casescenarioofsellinganoptionisretainingtheoptionpremium,whereasthedownsidelosscanbequitesubstantialif theprivatesignalturnsouttobeincorrect.

9_We_will_examine_in_later_sections_whether_the_aggressive_trading_of_foreign_{institutional}_investors_is_based_upon_their

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Detailsofthevolumedistributionforeachofthefourclassesoftradersinopen-buy,open-sell,

close-buyandclose-selltransactionsareprovidedinPanelCofTable1.Ofthefourtypesof

transac-tions,themostlikelytobepursuedbytradersinpossessionofsuperiorinformationonfutureprice

movementswouldpresumablybeopen-buytransactions,sinceopentradesareoftenusedtoestablish

newpositionsforspeculatingpurposesinresponsetonewinformationwithinthemarket.Conversely,

closetrades(includingbothclose-buyandclose-sell)areregardedasbeinglessaggressive,essentially

becausetradersmayexecutesuchtransactionsasameansofrealizingtheirgainsoracceptingtheir

losses.

Opentradesthereforecontainmoreinformationthanclosetrades,andwhenengaginginopen

trades,buyingoptionsprovideshigherpotentialproﬁtsthansellingoptions;therefore,traderswho

aggressivelytradeontheirinformationaladvantagewouldtendtoinitiatemorelongpositionsinorder

tomaximizetheirspeculativegains.Takingallofthesefactorstogether,sinceopen-buytransactions

maywellbeusedforinformedtrading,theyarelikelytohavemuchricherinformationcontentthan

othertypesoftransactions(PanandPoteshman,2006).

AsshowninPanelCofTable1,foreigninstitutionalinvestorsdevote55.62percentoftheirtrading

volumetoopen-buy transactions,asigniﬁcantlygreaterproportionthanthatofanyoftheother

threeclassesoftraders.Thissubstantiallylargerproportionofopen-buytradingindicatesthatforeign

institutionalinvestorsarelikelytopossesssuperiorinformationandaggressivelyuseopen-buyoption

transactionsinordertorealizetheirinformationaladvantage.10

4. Methodology

Theinformationcontentofoptionsisassessedthroughoutthisstudybythepredictiveabilityof

optionvolumeonfutureindexreturns,withourempiricalmodelfollowingthespeciﬁcationsofPan

andPoteshman(2006)toregressthenext-dayspotmarketreturnagainsttheoptionput-callvolume

ratio.Theoptionput-callvolumeratio,whichrepresentstheinformationpossessedbyoptiontraders

onfuturechangesinthedirectionoftheindex,isdeﬁnedinthisstudyastheopen-buyputtrading

volume(innumberofcontracts)dividedbythesumofopen-buyputandopen-buycallvolume.

Changetal.(2009)subsequentlywentontosuggestthattheput-callratiocouldbeusedtoexamine

whetheraparticularclassoftraderspossessedsuperiorinformationoverothermarketparticipants,

withthecalculationbeingbasedupontransactionsfromasubsetoftraderclasses.Ourbasicregression

modelfollowsthissuggestiontoregressthenext-daystockindexreturnsontheput-callvolumeratios

calculatedforeachofthefourclassesoftradersshowninTable1.

Thebasicmodelusedthroughoutthisstudyisasfollows:

Rt₊₁=˛i+ˇi,upXi,t×Dt+ˇi,downXi,t×(1−Dt)+εi,t (1)

Dt=

1, Rt>0;

0, otherwise

whereRt+1isthedailyclose-to-closereturnontheTWIspotindexatdatet+1,whichweconvert

intobasispointsbeforeperformingtheregressions;Xi,tistheinformationvariableproxiedbythe

open-buyput-callvolumeratios(calculatedfromthetransactionsoftraderclassiatdatet);andDt

isadummyvariablewhichisequalto1ifthecontemporaneous(dayt)marketreturnispositive;

otherwise0.

10_When_examining_Panel_C_of_Table_1,_we_may_expect_the_open-buy_(open-sell)_volume_being_equal_to_the_close-sell

(close-buy)volume;however,anumberofpracticalissuesinterferewiththeequalityrelationship.Firstly,theclose-sellvolumeof marketmarkersismorethantheiropen-buyvolume,essentiallybecauseduringoursampleperiodsomemarketmakerswere disqualiﬁedwhilstotherswerenewly-licensed,whichalterstheidentityofthetradersandmakesitdifﬁculttopreciselymatch theopen-buyandclose-sellvolumewithinanyparticulartradertype.Secondly,theclose-sellvolumecouldbesmallerthanthe open-buyvolumewhensomeopen-buycontractsareheldtoexpirationandsettledforcash;insuchcases,therewillnotbea correspondingclose-selltransactionforanopen-buyposition.Thesameexplanationappliestothesmallerclose-buyvolume thanopen-sellvolume.

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TheinformationvariableXi,tisdeﬁnedas: Xi,t=

Pi,t Pi,t+Ci,t

(2)

wherePi,tandCi,t aretherespectivenumbersofcontractsfortheopen-buyputandcalltradesof

investorclassiatdatet.Iftheopen-buyvolumeofaparticularclassoftraderspredictsthesubsequent

movementsintheindex,thenwewouldexpecttoobservesigniﬁcantlynegativeˇcoefﬁcients.

FiglewskiandWebb(1993)andDanielsenandSorescu(2001)suggestedthattheshort-sales

con-straintsinthestockmarketresultininvestorstradinginderivativesinresponsetobadnews.Ifthis

isthecase,thenoptionswouldbemoreinformativeonadaywhentherewasadeclineinthemarket

(whenspottradingismoresubjecttoshort-salesconstraints),ascomparedtoadaywhenthereisan

increaseinthemarket(whenfewerstocksarehinderedbyshort-salesconstraints).Weincludean

indicativevariable(Dt)toseparatetheupanddownmarketdays,andallowthisvariabletointeract

withtheput-callratios.Anegativelysigniﬁcantˇi,up(ˇi,down)wouldindicateatendencyforinformed

tradingtobetakingplaceinanupward(downward)market.11

Thebasicmodelcalculatesthevolumeratiousingonlyopen-buyvolume,becauseweexpectto

ﬁndthattheopen-buyvolumewillbemoreinformativethantheotherthreetypesofvolume.The

basicmodelisexpandedinEq.(3)byincludingadditionalthreevolumeratiosforopen-sell,close-buy

andclose-sellvolume,withthevolumeratiosbeingdeﬁnedinaccordancewithEq.(2).Allofthese

volumeratiosaresettointeractwiththeupward/downwarddummyvariable.

Thisalternativeregressionmodelisspeciﬁedas:

R_t+1 =˛i+[ˇOBi,upX OB i,t +ˇ OS i,upX OS i,t +ˇ CB i,upX CB i,t+ˇ CS i,upX CS i,t]×Dt+[ˇ OB i,downX OB i,t +ˇ OS i,downX OS i,t

+ˇCB_i,downX_i,tCB+ˇCS_i,downXCS_i,t]×(1−Dt)+εi,t (3)

Dt=

1, Rt>0;

0, otherwise

whereXOB

i,t,Xi,tOS,Xi,tCBandXi,tCSrespectivelyrefertotheopen-buy,open-sell,close-buyandclose-sell put-callratios.

Speculatingonanupwardmovementintheindex,informedtraderswouldtendtopurchasecalls

(open-buycalls),sellputs(open-sellputs),closeexistingshortcallpositions(close-buycalls)orclose existinglongputpositions(close-sellputs).TheresultoftheirtradingwouldbetoraiseXOS_and_XCS_,

whilstdepressingXOB_and_XCB_._Similarly,_traders_who_have_expectations_of_a_decline_in_the_index_would

tendtosellcalls(open-sellcalls),buyputs(open-buyputs),closeexistinglongcallpositions(close-sell

calls)orcloseexistingshortputpositions(close-buyputs).Theendresultoftheirtradingwouldbe

tolowerXOS_and_XCS_,_whilst_raising_XOB_and_XCB_._If_certain_classes_of_traders_were_to_consistently_make

correctpredictions,wewouldthenobserveanegativecoefﬁcientonbothˇOB_and_ˇCB_,_and_a_positive

coefﬁcientonbothˇOS_and_ˇCS_,_as_the_information_variables_reﬂecting_their_open-buy,_close-buy,

open-sellandclose-selltransactions.

11_It_should_be_noted_that_our_deﬁnition_of_up/down_markets,_which_is_dependent_on_the_index_return_at_day_t,_differs_from

theconventionalidentificationofbull/bearmarkets,basedonreturnsoveralongerperiodoftime.Ourmodelisdesignedto examinetheeffectofshort-salesconstraintsoninformedtradingintheoptionsmarket;toachievethisaim,theoveralleffect ofshort-salesconstraintscanbemorepreciselyidentifiedbydefiningup/downmarketsbasedontheindexreturnatdayt,as opposedtoreturnsoveralongerperiod.ThesamedefinitionwasadoptedbyChenandRhee(2010)toidentifytheroleofshort salesontheinformationefficiencyofstocksinupversusdownmarketsandHameedetal.(2010),whomodeledtheeffectof marketreturnsonthebid-askspread,conditionalonthedirectionoftheindexmovementondayt.

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5. Empiricalresults

5.1. Identifyinginformedtraders

ThepredictiveregressionresultsofEqs.(1)and(3)foreachclassoftradersarepresentedinTable2,

withtheﬁrstandsecondcolumnrespectivelyreportingthecoefﬁcientvariablesandtheirexpected

signs(−or+)iftheput-callvolumeratiocorrectlypredictsthenextdayindexreturn.Thenumbers

showninboldtextindicatethatthecoefﬁcientsarestatisticallysigniﬁcantandthattheirsignssupport

thepredictiveabilityoftheput-callratio.

Severalimportant ﬁndings arehighlighted, as follows.Firstly,of the fourdifferent classesof

investors,theoptiontradingpositionsofforeigninstitutionalinvestorsappeartoprovidethemost

accurateforecastingofthenext-dayspotindex,astheiropen-buyvolumeratioisfoundtobe

neg-ativelyassociatedwiththenext-dayindexreturninEq.(3),withstatisticalsigniﬁcanceatthe1per

centlevel.Thisindicatesatendencyforariseinthenext-dayindexasforeigninstitutionalinvestors

increasetheiropen-buycallsrelativetoopen-buyputs,andviceversa.Theclose-sellratioof

for-eigninstitutionalinvestorsalsocorrectlypredictsthenext-dayindexreturn,albeitwithmarginal

signiﬁcance.

AsregardsEq.(1),whereonlytheopen-buyvolumeratioisincluded,ofthefourclassesoftraders,

onlytheopen-buypositionsofforeigninstitutionalinvestorsarefoundtohaveanysigniﬁcant

cor-relationwithnext-dayindexreturns.Furthermore,thepredictiveregressionforforeigninstitutional

investorsisfoundtoyieldthehighestR2_levels_amongst_all_of_the_regressions_under_the_same_model,

whichtherebysuggeststhatthevolumeratiosofforeigninstitutionalinvestorsarecapableof

explain-ingagreaterproportionofthevariationinthenext-dayreturnsthanthevolumeratiosofallother

typesoftraders.12

Secondly,thepredictiveabilityofthevolumeratiosofforeigninstitutionalinvestorsisfoundto

prevailonlyinadownwardmarketbutcompletelyabsentinanupwardmarket.PanelAofTable2

showsthatthecoefﬁcientontheopen-buyvolumeinadownwardmarket(ˇOB

down)isnegativeand

statisticallysigniﬁcant,whereasthecoefﬁcientinanupwardmarket(ˇOB

up)isinsigniﬁcant.Such

asym-metryinpredictiveabilityisconsistentwithanalysesreportedinthepriorstudiesandmaywellreﬂect

theeffectofshort-salesconstraintsintheTaiwanspotmarket.13

Forexample,fromtheirexaminationofequityoptions,DanielsenandSorescu(2001)demonstrated

thattheshort-salesconstraintsimposedonthespotmarketmaywellresultintraderswithsuperior

informationbeingforcedtotradeontheirinformationintheequityoptionsmarkets.Ourevidence

furtherindicatesthattherestrictionsonshort-sellingstockscouldalsoresultinstrongerdemandfor

indexoptionsinadownwardmarket,essentiallyforthepurposeofhedgingagainstthedownsiderisk

andspeculatingonanupcomingdecline.Asinformedtradersrushtoopenhedgingorspeculative

positionsinindexoptions,theiroptionvolumeratiosbecomemoreinformative.

Wecarryoutthetestsforthefollowingtwoimplicationsinordertofurtherinvestigatethe

short-saleshypothesis.Ifthevalueoftheinformationrelatingtotheoptionisenhancedwithstricterspot

short-salesrestrictions,then:(i)thepredictiveabilityoftheoptionvolumeratioshouldbemore

pronouncedwhenthereturnatt+1isnegativethanwhenitispositive;and(ii)thepredictiveability

shouldhavebeenweakenedafter12November2007,whentheTaiwanStockExchangeliftedthe

‘up-tick’ruleforaround150liquidstocks.Theresultsofthesetwotestsontheopen-buyvolumeratio

offoreigninstitutionalinvestorsarepresentedinTable3.14

12_The_predictive_regressions_usually_yield_low_R2_values._The_R2_values_in_the_present_study_are_comparable_to_those_of_Chang

etal.(2009),whoreportedR2_ranging_from_0.0016_to_0.0087_for_similar_predictive_regressions_of_index_returns_on_put-call

ratios.

13_The_short-sales_constraints_within_the_Taiwan_stock_market_comprise_of:_(i)_the_limited_availability_of_shares_to_borrow;_(ii)_a

marginrequirementofabove110%oftheshareprice;(iii)therequirementforshortsellerstocovertheirshortpositionsduring awindowsurroundingex-dividenddays;and(iv)the‘up-tick’rulewherebyastockistemporarilybannedfromshort-sales transactionswhenthecurrentstockpricehasfallenbelowtheclosingpriceontheprevioustradingday.Althoughthe‘up-tick’ rulewasliftedforaround150ofthemostliquidstocksafter12November2007,itremainedinplaceforallotherstocks.

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Theoverallsampleisdividedintotwosub-samplesinPanelA,withtheﬁrstofthesesub-samples

comprisingofcases(days)forwhichRt+1>0,andthesecondcomprisingofcases(days)forwhich

Rt+1≤0.Theresultsofourregressionsarefoundtobeconsistentwiththeshort-saleshypothesis,

thatthepredictiveabilityofoptionswillbehigherinthosecaseswheretheindexreturnatt+1is

negative,ascomparedtowhenitispositive.Theˇdowncoefﬁcientisfoundtobesigniﬁcantlynegative

fortheRt+1≤0sub-sample(withpredictiveability)whereasnostatisticalsigniﬁcanceisfoundinthis

coefﬁcientfortheRt+1>0subsample.15

In PanelBofTable3,thesampleisdividedintotwosub-periods,pre-andpost-12November

2007,whentheTaiwanStockExchangerelaxedtheup-tickruleforaround150liquidstocks.We

allowtheindependentvariabletointeractwithanindicativevariable,S,whichisequalto1ifthe

observationoccurspriorto12November2007,otherwise0.Theresultslendfurthersupporttothe

short-saleshypothesis,withtheonlysigniﬁcantcoefﬁcientwithacorrectpredictivesignbeingˇBefore_down,

thecoefﬁcientforthevolumeratiopriortotherelaxationoftheup-tickruleforobservationsona

downmarketday.Aftereasingtheshort-salesconstraints,thepredictiveabilityofoptionsonadown

marketday,asshownbyˇAfter_down,isfoundtobestatisticallyinsigniﬁcant,albeitwiththecorrectsign.

Ourﬁndingsareconsistentwithanumberofthepriorstudieswheretheasymmetricinformation

efﬁciencyin upversusdownmarketsisattributedtoshort-salesconstraintsor shortselling. For

example,Chanet al.(2009)identiﬁedanenhancedleadingrole ofoptionsovertheequityindex

duringdownwardtrendperiods,whilstLeeandWang(2012)documentedastronginformationalrole

intheshort-sellingactivitiesofforeigninstitutionalinvestorswithintheKoreanstockmarket.Safﬁ

andSigurdsson(2011)alsoreportedlowerpriceefﬁciencyforthosestocksthatweresubjecttohigher

short-salesconstraints.

Our thirdimportantﬁndingisthatthepositionsofmarketmakerscanhardlybeclassiﬁedas

outcomesofinformedtrading.InPanelBofTable2,mostofthecoefﬁcientsarefoundtohavethe

oppositesigntothatspeciﬁedintheﬁrstcolumn.Evenworse,marketmakers’open-buyand

open-sellratiosexhibitasigniﬁcantshiftinthewrongdirectioninthecaseofdownwardindexmovements.

Thisfindingmaylookquiteoddatfirstglance,giventhatmarket-makingfirmsinTaiwanareoperated

byprofessionalswithexpertiseandexperienceinoptionstrading;however,itmaybereconciled

byrecognizingtheprimaryroleofmarketmakersasliquidityproviders.Whilstprovidingliquidity

topotentialinformedtraders,thesemarketmakersareessentiallyleaningagainstthewind.Asa

consequence,theoppositeandsignificantregressioncoefficientsmerelyreflectthefactthattheyare

indeedfulﬁllingtheirobligationbytakinguppositionsontheoppositesideofinformedtrading.16

Fourthly,neitherdomesticinstitutionalinvestorsnorretailinvestorsarewellinformedwhen

trad-inginindexoptions;indeed,theopen-buyvolumeofdomesticinstitutionalinvestorsinadownward

markethasanegativecoefﬁcientandap-valueof0.0935forregressionModel(3).Asidefromthis

marginalpredictiveability,tradingbydomesticinstitutionalinvestorsinanupwardmarketappears

toresultinshort-termlosses,sincetheirˇOS

up,ˇCBupandˇCSupcoefﬁcientsexhibitoppositesignstoour

expectations.Itshouldbenotedthatthedeﬁnitionof‘domesticinstitutionalinvestors’providedby

theTAIFEXincludesmutualfunds,banksandcorporations,whilstexcludingfuturesproprietaryﬁrms

(primarilycategorizedasmarketmakers).Sincetradinginoptionsbythesemarketparticipantsis

largelyforhedgingpurposes,theirpositionsshouldberelativelyuninformative.

Asregardsindividualtraders,allofthecoefﬁcientsinthetworegressionsarefoundtobe

insignif-icant,despitesomesignsbeingconsistentwiththenext-dayindexreturns.Thisﬁndingissimilarto

thosereportedinseveralofthepriorstudiesinwhichitisnotedthatgiventheirdisadvantagesin

15_We_also_examine_an_alternative_model,_where_the_dummy_variable_D

t(thepositive/negativeindicatoroftheindexreturn

ondayt)inEq.(1)isreplacedbyDt+1(thepositive/negativeindicatoroftheindexreturnondayt+1).Thecoefﬁcientofˇdown

isfoundtobesigniﬁcantlynegative(−210.61,p-value<0.0001),whereasthecoefﬁcientofˇupisfoundtobepositive(126.43,

p-value<0.0001).Theseresultsprovidesupportfortheshort-saleshypothesis,thatthepredictiveabilityofoptionswilltend tobehigherwhentheindexreturnondayt+1isnegativeascomparedtowhenitispositive.Thismodelmay,however,suffer fromtheproblemofendogeneity,sinceRt+1appearsonbothsidesoftheequation;therefore,thisresultisnottabulated.

16_The_result_here_should_not_be_taken_as_evidence_that_market_makers_incur_short-term_losses._In_order_to_assess_the_net

tradingproﬁts/lossesofanymarketmakers,weneedtotakeintoaccountthecompensationthatmarketmakersreceivefrom thebid-askspread.

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Table2

Predictiveabilityofoptionput-callvolumeratios.

Variables Expectedsignifwithpredictiveability Eq.(3) Eq.(1)

Coefﬁcient p-Value Coefﬁcient p-Value

PanelA:foreigninstitutions

Intercept 31.22 0.3682 28.96 0.1766 ˇOB up − −22.50 0.7230 −48.48 0.2517 ˇOS up + −112.53 0.1213 – – ˇCB up − −14.23 0.7110 – – ˇCS up + 43.98 0.2985 – – ˇOB down − −176.63 *** _0.0097 _−64.23* _0.0833 ˇOS down + 1.48 0.9844 – – ˇCB down − 39.28 0.3922 – – ˇCS down + 76.32 * _0.0836 _– _– R2 _0.0401 _0.0085

PanelB:marketmakers

Intercept −13.14 0.8030 −45.77 0.1987 ˇOB up − 113.32 0.3518 106.50 0.1865 ˇOS up + −19.25 0.8789 – – ˇCB up − −50.29 0.7250 – – ˇCS up + −3.09 0.9825 – – ˇOB down − 249.48 * _0.0749 _83.70 _0.2455 ˇOS down + −283.92 * _0.0770 _– _– ˇCB down − 177.06 0.3341 – – ˇCS down + −150.54 0.3355 – – R2 _0.0165 _0.0048

PanelC:domesticinstitutions

Intercept 35.74 0.4334 18.16 0.5558 ˇOB up − 40.81 0.5395 −29.14 0.6042 ˇOS up + −169.07* 0.0790 – – ˇCB up − 182.79** 0.0430 – – ˇCS up + −124.44* 0.0638 – – ˇOB down − –123.50 * _0.0935 _–39.09 _0.4411 ˇOS down + 61.67 0.5272 – – ˇCB down − 30.37 0.7389 – – ˇCS down + −2.33 0.9739 – – R2 _0.0284 _0.0020

PanelD:individualinvestors

Intercept 35.35 0.6645 −15.62 0.7083 ˇOB up − 156.90 0.3281 43.83 0.6740 ˇOS up + −3.68 0.9787 – – ˇCB up − −157.54 0.3059 – – ˇCS up + −48.00 0.7738 – – ˇOB down − −93.51 0.6308 28.26 0.8046 ˇOS down + 33.17 0.8307 – – ˇCB down − −78.98 0.6693 – – ˇCS down + 35.37 0.8067 – – R2 _0.0064 _0.0010

Thistablereportstheresultsofthefollowingpredictiveregressionsforeachofthefourclassesofinvestors.

Rt+1=˛i+ˇi,upXi,t×Dt+ˇi,downXi,t×(1−Dt)+εi,t (1)

Rt+1 =˛i+

ˇOB i,upX OB i,t+ˇ OS i,upX OS i,t+ˇ CB i,upX CB i,t+ˇ CS i,upX CS i,t

×Dt+

ˇOB i,downX OB i,t+ˇ OS i,downX OS i,t+ˇ CB i,downX CB i,t+ˇ CS i,downX CS i,t

×(1−Dt)+εi,t (3)

whereRt+1isthedailyclose-to-closespotindexreturnondayt+1;XS(Xi,t=Pi,t/(Pi,t+Ci,t))aretheput-callvolumeratioscalculated

usingopen-buy(OB)andopen-sell(OS)volume,andclose-buy(CB)andclose-sell(CS)volume;andDisanindicativevariable whichisequalto1ifRt>0;otherwise0.Thesignsofthecoefﬁcientssupportingthepredictiveabilityofthevolumeratioare

indicatedbyaplus(+)oraminus(−)inthefirstcolumn.Boldnumbersindicatecoefficientswithcorrectpredictivesignsand statisticalsignificance.

*_Indicates_statistical_{significance}_at_the_10%_level. **_Indicates_statistical_{significance}_at_the_5%_level. ***_Indicates_statistical_{significance}_at_the_1%_level.

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Table3

Inﬂuenceofshort-salesrestrictionsonthepredictiveabilityofforeigninstitutionalinvestors.

Variables Coefﬁcient p-Value

PanelA:predictiveabilityconditionalonreturndirectionondayt+1

a.SubsampleRt+1>0(169observations) Intercept 123.06*** _<0.0001 ˇup 36.71 0.4778 ˇdown −10.17 0.8164 Intercept −117.89*** _<0.0001 R2 _0.0131 b.SubsampleRt +1≤0(198observations) ˇup −46.63 0.1458 ˇdown −73.09* 0.0811 Intercept 34.59 0.1137 R2 _0.0112

PanelB:predictiveabilityconditionalonsub-periodsbeforeandafterstrictershort-salesrestrictions

ˇBefore up −78.78 0.1527 ˇBefore down −102.01 ** _0.0266 ˇAfterup −48.57 0.2607 ˇAfter_down −54.54 0.1601 R2 _0.0143

PanelAreportstheresultsonthepredictiveabilityofforeigninstitutionalinvestors,ontwosub-samplescomprisingofcases whereRt+1>0andwhereRt+1≤0,baseduponthefollowingpredictiveregression:

Rt+1=˛+ˇupXt×Dt+ˇdownXt×(1−Dt)+εt,

whereRt+1isthedailyclose-to-closespotindexreturnondayt+1;Xt=(Pt/(Pt+Ct))istheput-callvolumeratiocalculatedusing

open-buy(OB)volumeofforeigninstitutionalinvestors;andDtisanindicativevariablewhichisequalto1ifRt>0;otherwise

0.Coefficientswithanegativesignareconsistentwiththepredictiveabilityofforeigninstitutionalinvestors.Boldnumbers indicatecoefficientswithcorrectpredictivesignsandstatisticalsignificance.

PanelBreportstheresultsconditionalonthetwosub-periodssubjecttodifferentshort-salesrestrictions,baseduponthe followingpredictiveregression:

Rt+1=˛+

ˇBeforeup Xt×Dt+ˇBefore_downXt×(1−Dt)

×St+

ˇAfterup Xt×Dt+ˇAfter_downXt×(1−Dt)

×(1−St)+εt,

whereDtisanindicativevariablewhichisequalto1ifRt>0,otherwise0;Stisanindicativevariablewhichisequalto1if

theobservationoccurredpriorto12November2007(thedateonwhichtheTaiwanStockExchangeeasedtheup-tickrulefor around150liquidstocks),otherwise0.Allothervariablesareasdeﬁnedpreviously.

*_Indicates_statistical_{significance}_at_the_10%_level. **_Indicates_statistical_{significance}_at_the_5%_level. ***_Indicates_statistical_{significance}_at_the_1%_level.

trading against professionals (in terms of capital, expertise and research resources), individual

investorscontributelittletopricediscoveryorthedisclosureofinformationonfutures(Frinoetal.,

2004;ChouandWang,2009),options(Ahnetal.,2008;Hanetal.,2009)orspotequities(Grinblatt andKeloharju,2000;Barberetal.,2009).

TheEqs.(1)and(3)regressionresultsindicatethattheopen-buyratioismoreinformativethan

theotherthreevolumeratios,whichisconsistentwiththesuggestionofPanandPoteshman(2006)

thatanopen-buystrategyrepresentsamoreaggressivestrategywhentradershavestrongviewson

futurepricemovements,therebyrevealingricherinformationcontentthanopen-sell,close-buyand

close-sellstrategies.Oursubsequentanalysisthereforefocusesentirelyonthepredictiveabilityofthe

open-buyvolumeratio.

OurregressionresultsusingEq.(1)showadeclineof64.23basispointsinthenext-dayindex

followingaoneunit increase(from0to1)intheopen-buyput-callratioofforeigninstitutional

investors.Translatingthisintoamoreplausiblevariationintheput-callratio,aonestandard

devia-tion(21percent)changeintheput-callratioisassociatedwitha−13.48basispointchangeinthe

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Table4

Predictiveabilityoftheopen-buyratioconditionalonoptionmarketactivity.

Variables Foreigninstitutions Marketmakers Domesticinstitutions Individualinvestors Coefficient p-Value Coefficient p-Value Coefficient p-Value Coefficient p-Value

PanelA:lowaggregateoptionvolume(below33%)

Intercept 47.01 0.1944 −118.37* _0.0576 _65.85 _0.2433 _4.02 _0.9634 ˇup −80.67 0.2583 282.34** 0.0482 −114.83 0.2584 −3.04 0.9894

ˇdown −69.20 0.3085 275.32** 0.0448 −92.74 0.3155 13.23 0.9573

R2 _0.0114 _0.0351 _0.0109 _0.0004

%ofContracts 23.91 22.18 27.50 26.41

PanelB:mediumaggregateoptionvolume(between33%and67%)

Intercept −25.36 0.4875 46.70 0.4096 43.86 0.3274 −12.67 0.8372

ˇup 42.34 0.5408 −131.06 0.3035 −100.90 0.2226 4.71 0.9745

ˇdown 22.77 0.7120 −120.34 0.3217 −93.50 0.2224 5.21 0.9750

R2 _0.0034 _0.0089 _0.0131 _0.0000

%ofContracts 34.00 32.49 33.41 32.92

PanelC:highaggregateoptionvolume(above67%)

Intercept 52.98 0.1836 −77.17 0.2875 −61.47 0.3064 −51.69 0.4912 ˇup −88.19 0.2856 202.56 0.2130 146.36 0.1819 172.50 0.3589

ˇdown −120.54* 0.0680 122.57 0.3554 74.56 0.4396 102.26 0.6131

R2 _0.0308 _0.0161 _0.0223 _0.0146

%ofcontracts 42.09 45.33 39.09 40.67

Thistablereportsthepredictiveregressionresultsconditionalondailyoptionstradingvolumeandtraderclasses;the367 tradingdaysaresortedintothreeequal-sizedsub-samplesbasedonthedailyoptiontradingvolume.Theregressionmodel carriedoutforeachvolumetertileis:

Rt+1=˛i+ˇ_i,upOB,volumepercentileX_i,tOB,volumepercentile×Dt+ˇ_i,downOB,volumepercentileX_i,tOB,volumepercentile×(1−Dt)+εi,t

Dt=

1,Rt>0;

0,otherwise

,

whereRt+1isthedailyclose-to-closespotindexreturnondayt+1;XSaretheopen-buyput-callratios;andDisanindicative

variablewhichisequalto1ifRt>0;otherwise0.Theopen-buyput-callratioiscalculatedbydividingtheopen-buyputsbythe

sumoftheopen-buyputsandcalls.The‘%ofContracts’referstothepercentageofopen-buyvolumewithinthespecifictrader class.Boldnumbersindicatecoefficientswithcorrectpredictivesignsandcorrectstatisticalsignificance.

*_Indicates_statistical_{signiﬁcance}_at_the_10%_level. **_Indicates_statistical_{signiﬁcance}_at_the_5%_level.

changeof63.82points,the−13.48basispointsapproximatetoa−11.43changeintheindexlevel

(−13.48×10−3×8476),whichis18percentofthemediandailyindexmovement(11.43/63.82).

Whentakingintoconsiderationtheslopecoefﬁcientof176.63basispointsinEq.(3),thissuggests

thataonestandarddeviationchangeintheput-callratioisassociatedwitha−31.42indexmovement,

whichaccountsfor49percentofthemediandailyindexchangeinoursampleperiod.Theseresults

indicatethattheput-callratiosofforeigninstitutionalinvestorspredictanon-trivialportionofthe

indexmovements,andthus,shouldbeconsideredtobeofeconomicsigniﬁcance.Theslopecoefﬁcients

aresixtimesgreaterwhenweexamineasub-samplecontainingonlythosedayswithimportant

macroeconomicnewsevents(Table8).

5.2. Marketactivityandthepredictiveabilityofoptions

Wegooninthissectiontoexaminewhetherthereareanyvariationsinthepredictiveability

oftradingbyforeigninstitutionalinvestorsunderdifferentlevelsofoptionmarketactivity.Studies

havelongviewedtradingvolumeandinformationﬂowasinseparable;forexample,inthe‘sequential

arrivalofinformation’modelproposedbyCopeland(1976),thegradualarrivalanddisseminationof

newinformationresultsinmovementsinbothtradingvolumeandprice.17

17_Evidence_of_volume_stimulated_by_information_was_found_by_Kim_and_Verrecchia_(1991),_who_demonstrated_that_trading

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Table5

Predictiveabilityoftheopen-buyratio,byoptionmarketcharacteristics.

Variables Foreigninstitutions Marketmakers Domesticinstitutions Individualinvestors Coefficient p-Value Coefficient p-Value Coefficient p-Value Coefficient p-Value

PanelA:moneyness

a.In-andnear-the-money

Intercept 17.56 0.2995 23.35 0.2032 –1.28 0.9390 –4.99 0.8076 ˇup −39.71 0.3262 −81.22 0.1528 3.51 0.9335 12.30 0.8482 ˇdown −40.05 0.1889 −47.71 0.1913 −2.82 0.9228 7.68 0.8727 R2 _0.0048 _0.0061 _0.0001 _0.0001 %ofcontracts 31.35 41.99 36.00 38.24 b.Out-of-the-money Intercept 24.16 0.2047 −35.73 0.0917 −14.21 0.5240 −25.79 0.2290 ˇup −36.62 0.2833 70.25 0.0733 22.02 0.5327 60.15 0.1891 ˇdown −54.04* 0.0943 65.21 0.1453 19.61 0.6000 59.37 0.3403 R2 _0.0078 _0.0088 _0.0011 _0.0048 %ofcontracts 50.40 43.61 44.82 42.07

A.3Deeplyout-of-the-money

Intercept −10.77 0.5164 −31.91 0.1400 −32.06 0.1152 −34.39* _0.0607 ˇup 22.52 0.3881 42.30 0.1455 45.45* 0.0955 55.99** 0.0798

ˇdown 3.13 0.9056 36.94 0.2778 39.49 0.2211 68.65 0.1160

R2 _0.0031 _0.0060 _0.0083 _0.0093

%ofcontracts 18.25 14.40 19.18 19.69

PanelB:timetomaturity

a.Short(lessthan30days)

Intercept 19.35 0.3391 −21.62 0.5322 14.23 0.6353 −12.74 0.7582 ˇup −27.20 0.4794 54.54 0.4893 −22.07 0.6925 38.01 0.7108 ˇdown −49.96 0.1565 31.82 0.6534 −34.13 0.4965 16.92 0.8798 R2 _0.0066 _0.0019 _0.0018 _0.0012 %ofcontracts 71.84 91.87 91.09 93.21 b.Medium(30–90days) Intercept 22.01 0.1525 9.05 0.6272 −23.67 0.2804 −9.11 0.5824 ˇup −38.32 0.2000 −25.06 0.4894 54.41* 0.0912 37.24 0.4601 ˇdown −51.65* 0.0517 −17.84 0.5774 27.40 0.4198 8.18 0.8981 R2 _0.0106 _0.0014 _0.0136 _0.0021 %ofcontracts 26.69 7.86 8.70 6.65

c.Long(morethan90days)

Intercept −8.87 0.6215 0.88 0.9617 5.18 0.9619 9.73 0.4447

ˇup 26.43 0.3807 2.98 0.9143 −4.31 0.9716 −33.68 0.3702

ˇdown 13.32 0.6481 −13.24 0.6082 5.76 0.9626 −45.61 0.3047

R2 _0.0029 _0.0021 _0.0019 _0.0036

%ofcontracts 1.47 0.27 0.21 0.13

Thistablereportstheresultsofthefollowingpredictiveregressionmodel,byoptioncharacteristics(moneynessormaturity) andtraderclasses:

Rt+1=˛i+ˇ_i,upOB,option leverageX_i,tOB,optionleverage×Dt+ˇOB,option_i,down leverageXOB,option_i,t leverage×(1−Dt)+εi,t,

whereRt+1isthenext-dayspotindexreturn;XSaretheopen-buyput-callvolumeratioscalculatedforaspeciﬁctype(moneyness

ormaturity)ofoptions;andDisanindicativevariablewhichisequalto1ifRt>0;otherwise0.Theopen-buyput-callratiois

calculatedbydividingtheopen-buyputvolumebythesumoftheopen-buyputandcallvolumeforthecorrespondingtypeof options.The‘%ofContracts’ineachpanelreferstotheopen-buyvolumeofthatcategoryasapercentageofthetotalopen-buy volumefortheentireclassoftraders.WedefineIn-andNear-the-Moneyoptionsasthosewithstrike-to-spotratiosbetween 0.98and1.02,Out-of-the-Moneycallsasthosewithstrike-to-spotratiosbetween1.02and1.07,andOut-of-the-Moneyputs asthosewithstrike-to-spotratiosbetween0.93and0.98.AllotheroptionsareclassifiedasDeeplyOut-of-the-Moneyoptions. Thoseoptionsthatexpirewithin30daysareclassifiedasshortmaturityoptions,thoseexpiringbetween30to90daysas mediummaturityoptions,andtheremainderaslongmaturityoptions.The‘%ofContracts’referstothepercentageofopen-buy volumewithinthespecifictraderclass.Boldnumbersindicatecoefficientswithcorrectpredictivesignsandcorrectstatistical significance.

*_Indicates_statistical_{signiﬁcance}_at_the_10%_level. **_Indicates_statistical_{signiﬁcance}_at_the_5%_level.

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Analternativeexplanationoftheassociationbetweenvolumeandinformationwasalsooffered byKyle(1985)andAdmatiandPfeiderer(1988),whosuggestedthatinordertobothconcealtheir

informationandlowerthepriceimpact,informedinvestorswouldtendtotradewhenliquiditytrading

wasinplentifulsupply.18_Both_theories_imply_that_the_timing_of_order_submissions_by_informed_traders

isrelatedtomarketactivity.

ToidentifywhetherinformedtradingontheTXOisdependentonmarketactivity,wesortthe367

tradingdaysintothreeequal-sizedsub-samplesbasedondailyoptiontradingvolume.Thepredictive

regressionEq.(1)isthenseparatelycarriedoutforeachvolumetertilesub-sample.Anegativeand

signiﬁcantˇcoefﬁcientwouldindicatethattheput-callvolumeratiocorrectlypredictsthe

next-dayindexreturn.AsshowninTable4,onlythetradingvolumeofforeigninstitutionalinvestorsin

thehighestvolumetertileisfoundtohaveasigniﬁcantˇcoefﬁcientandasignconsistentwithits

predictiveability.InPanelCtheregressionR2 _for_foreign_{institutional}_investors_is_found_to_be_the

highestamongstalltraderclasses.Thisconcentrationofinformationtradingduringperiodsofhigh

volumeisconsistentwiththeimplicationsofthesequentialarrivalofinformationandtheintention

toconcealinformation.

Chordiaand Swaminathan(2000)foundthathigh-volumestocksexhibitedrapidresponsesto

market-wideinformation, whereaslow-volumestockstendedtorespondveryslowly;thus,they

assertedthattradingvolumeplayedasigniﬁcantroleinthedisseminationofmarket-wideinformation.

Inthepresentstudy,wepresentevidenceinsupportoftheirassertion,albeitintheindexoptions

market,wherepricesaredeterminedmainlybymarket-wideinformation.

Ourresultsalsoprovidesupportforthepropositionthattraderswilltrytoconcealtheirsuperior

informationbytradingwhenthereisgreaterliquidity-motivatedvolumewithinthemarket.

Empha-sizingthedifferencesbetweentradingbasedonprivateinformationandpublicinformationthatis

subjecttodifferentinterpretations,Bamberetal.(1999)reportedthattradingbasedontraders’own

interpretationsofpublicly-availableinformationtendedtobemoreintensivewhentradingvolume

washigher,essentiallybecauseahighvolumeofliquiditytradinghelpstocamouﬂagetheir

trans-actions.Ourﬁndingofthesigniﬁcantpredictiveabilityoftradingbyforeigninstitutionalinvestors

duringperiodsofhighvolumereinforcestheﬁndingsofBamberetal.(1999)thattradersactingon

theirdifferentialinterpretationelecttotradewhenvolumeishigher.

TheremainingﬁndingsinTable4arelargelyconsistentwiththeresultsreportedinTable2,with

thesigniﬁcantpredictiveabilityoftheoptionpositionsofforeigninstitutionalinvestorsonlybeing

discernibleinadownwardmarket.Inthemarketmakerregressions,thetwoˇcoefﬁcientsinthe

lowestvolumetertilearefoundtobepositivewithstatisticalsigniﬁcance,therebyindicatingthatthe

obligationtoprovideliquiditywhenoverallliquidityislowexposesoptionmarketmakerstoadverse

selectionrisk.Theput-callratiosofindividualinvestorsandthevolumeratiosofdomesticinstitutional

investorsarefoundtohavelittleornoinformationcontentonfutureindexmovementsinanyofthe

volumetertiles.

5.3. Contractselectionbyinformedtraders

Inthissection,weexplorewhetherinformedtradersfavorcertaintypesofoptionswhenadopting

anopen-buystrategy.Speciﬁcally,weexaminethepredictiveabilityofopen-buyvolumeforoptions

atvariouslevelsofmoneynessandmaturity.

ItwasarguedinbothBlack(1975)andEasleyetal.(1998)thatinformedtradersoftenprefertotrade

inequityoptions,asopposedtotheunderlyingasset,essentiallybecausethehighleverageavailable

inoptionstradingraisesthepotentialproﬁtsfrominformedtrading.Accordingly,whenfacedwith

multipleseriesofoptions,informedtradersmaychooseout-of-the-moneyoptions,sincetheyprovide

alsoreportedabnormallyhightradingvolumeinequityoptionspriortotakeoverannouncements,indicatingthattraderswith superiorability,intermsoftheirinterpretationofinformation,tradeaheadofsuchannouncements.

18_Chakravarty_et_al.₍₂₀₀₄₎_found_that_option_markets_were_more_informative_when_the_trading_volume_was_high_and_the

effectivespreadswerenarrower.Blauetal.(2009)providedempiricalevidencetoshowthatasymmetricinformationwas greaterduringperiodsofhighvolume,wheninformedtraderswereabletosubmittheirorderswithoutrevealingtheirprivate information.

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higherleveragethaneitherin-the-moneyornear-the-moneyoptions.Theleverageconsiderationof

contractselectionisempiricallysupportedbyChakravartyetal.(2004),whofoundsigniﬁcantintraday

pricediscoveryforout-of-the-moneyoptionsascomparedtoat-the-moneyoptions,andKauletal.

(2004),whoshowedthatinformedtradersspeciﬁcallychoosetotradeinoptionswithgoodliquidity

andhighleverage.

Weclassifyoptionsintothreecategoriesofleverage,basedupontheirstrike-to-spotratios.

In-the-moneyandnear-the-moneyoptionsarecallsandputswithstrike-to-spotratiosbetween0.98

and1.02,whilstout-of-the-moneyoptionsarecallswithstrike-to-spotratiosbetween1.02and1.07

andputswithstrike-to-spotratiosbetween0.93and0.98.Deeplyout-of-the-moneyoptionsarecalls

withstrike-to-spotratiosabove1.07andputswithstrike-to-spotratiosbelow0.93.Thepredictive

regressioninEq.(1)isthencarriedoutonceagainusingthevolumeratioconstructedfromoptionsin

eachcategoryofmoneyness.

AsshowninPanelAofTable5,theonlysigniﬁcantput-callvolumeratioisfoundinthe

out-of-the-moneyoptionstradingofforeigninstitutionalinvestorsduringadownwardmarket;although

in-the-moneyandnear-the-moneyoptionstradedbythisgroupconveycorrectinformationon

next-dayindexmovements,thecoefﬁcientsarenotstatisticallysigniﬁcant.Noneoftheothertraderclasses

exhibitanysigniﬁcantpredictiveabilityinanycategoryofmoneyness.Theseﬁndingsareconsistent

withtheleveragehypothesis,thatinformedtradersprefertousehigh-leveragecontractsinorder

tocapitalizeontheirsuperiorinformation.Ourresultsalsoconﬁrmtheﬁndingsofthestudiesof

Ahnetal.(2008),Changetal.(2009)andChanetal.(2009),eachofwhichreportedatendencyfor

out-of-the-moneyoptionstoleadtheequityindexinpricediscovery.

Asidefromleverage,liquidityisanadditionalandcriticalconsiderationintheselectionofwhich

contractstotradein.Informed tradershaveanincentivetotrade ina liquidmarket inorder to

concealtheirprivateinformationandminimizethemarketimpactcosts(Kyle,1985).Weuse

time-to-expirationasaproxyforoptionliquidity,classifyingtheoptionsintothreematurityranges:less

than30days,between30and90days,andlongerthan90days,wheretheshort-term(lessthan

30days)optionsarethemostliquidandthelong-term(longerthan90days)optionsaretheleast

liquid.

Our predictive regressionsusingthe volumeratioconstructed fromoptionsin each maturity

categoryarepresentedinPanelBofTable5.Surprisingly,theonlyvariablewithasigncorrectly

andsigniﬁcantlypredictingthenext-dayindexreturnistheopen-buyratioofforeigninstitutional

investorsinmedium-termoptions,andnot,asmightbeexpected,theshort-termoptionswiththe

bestliquidity.Thisﬁndingis,nevertheless,consistentwiththosereportedbyHanetal.(2009)and

Changetal.(2009),bothofwhichundertookanalysesintoTXOoptionsandfoundbetterinformation

contentinmedium-maturityoptionsascomparedtoshort-maturityoptions.

Thisresultobviouslygivesrisetothequestionofwhyforeigninstitutionalinvestorsdonotchoose

toconcentratetheirinformedtradinginshort-termcontracts,wherethereissufﬁcientliquidity,and

theanswermayrelatetothetime-decaynatureofoptions.Theclosertheexpirationdate,thelarger

thetheta,andthus,themoretheoptionvalueisdiminishedwitheachpassingday.Theverynatureof

increasingvaluedecayovertimeisdetrimentaltoholdingshort-termlongoptionpositions.Informed

traders,whotendtoholdlongpositions(recallourﬁndingsinTables2and4),canmitigatetheextent

ofthevaluedecaybyselectingcontractswithlongertime-to-expiration.

Anadditionalmeritoftheuseoflonger-termoptionsisthatout-of-the-moneyoptionshavegreater

deltaswhentheoptionshavelongertime-to-expiration(Bakshietal.,2000).Thus,inordertogain

themaximumpossiblebeneﬁtfromtheirinformationaladvantage,foreigninstitutionalinvestorswill

tendtoselectthemedium-termcontracts,withhighdeltaexposure,amongtheout-of-the-money

options.Thiscontractselectionofinformedtradersisalsorevealedbytheirproportionalholdingof

optionsacrossmaturities.

Asshowninthe‘%ofcontracts’inPanelBofTable5,withtheexceptionofforeigninstitutional

investors,alltradersdevotedover90percentoftheirvolumetoshort-termoptions.Incontrast,foreign

institutionalinvestorsarefoundtohavetradedmoreinmedium-termoptions(26.69percent)than

othertraders(lessthan9percent).Theregressionresultsthereforesuggestthatthepreferencefor

medium-termoptionsamongstforeigninstitutionalinvestorscouldbemotivatedbytheopportunity

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Insummary,weﬁndthattheout-of-the-moneyandmedium-maturityoptionstradedbyforeign

institutionalinvestors havericherinformationcontent,andthatthedecisionsmadebyinformed

traderswithregardtotheircontractselectionreﬂecttheirwillingnesstosacriﬁceliquidityforhigh

leverage,highdeltaandlowtheta.

5.4. Stealthtradingintheindexoptionsmarkets

Inthissection,wegoontoexploretheinformation contentofoptionstradingusingdifferent

tradesizesinanattempttoprovidedirectevidenceof‘stealthtrading’intheindexoptionsmarket.

Thestealth-tradinghypothesisproposedbyBarclayetal.(1993)suggeststhatinformedtraderswill

oftenfragmenttheirlargeordersinordertoreducetheimpactonpricesandslowdowntheprocess

ofdisclosureoftheirvaluableinformation.Asaresult,itisthemedium-sizedtradeswhichtendto

havetherichestinformationcontentandwhicharemostlikelytomoveprices.Althoughahandfulof

studieshaveprovidedsupportforthishypothesisinthestockmarkets,thereislessevidencewithin

thederivativemarkets.19

FollowingAnandandChakravarty(2007),wedeﬁnesmall-sizedoptionstradesasthose

transac-tionscomprisingof1–4contracts,medium-sizedtradesasthoserangingbetween5and99contracts,

andlarge-sizedtradeasthoseinvolving100contractsormore.Wethengoontore-calculatethe

put-callratiosforeachclassoftraders,bytrade-sizegroups,andundertakethepredictiveregression

inEq.(1)foreachofthesetrade-sizegroups.TheresultsarereportedinTable6.

Theˇdowncoefﬁcientintheregressiononforeigninstitutionalinvestorsinadownwardmarketis

negativeforallthreetradesizes;however,itisonlyinthemedium-sizedregression(PanelB)thatthe

coefficientisfoundtobestatisticallysignificant.Thesignificantinformationalroleofthe

medium-sizedtradesmadebyforeigninstitutionalinvestorsisconsistentwiththestealthtradinghypothesis.

Indeed,ChouandWang(2009)notedfrequentorder-splittingbehavioramongstforeigninstitutional

investorsintheTaiwanfuturesmarket.

Itwouldseemthatwhenengagingininformedtrading,foreigninstitutionalinvestorsinTaiwan

tendtosplittheirlargeordersintomedium-sizedorders,withtheirmedium-sizedtradesultimately

providingthebestpredictionsonfutureindexmovements.Ourﬁndingsonindexoptionsare

consis-tentwiththosereportedonequityoptionsbyAnandandChakravarty(2007),whereinformedtraders

werealsofoundtoprefermedium-sizedtrades.

AsshowninTable6,approximately34percentofthetransactionsmadebyretailtradersare

small-sizedtrades,withthesetradessigniﬁcantlypredictingthewrongdirectionofchangesintheindex.

AccordingtoEasleyandO’Hara(1987),smalltradesarelikelytobeattributabletonoisetraders;we

alsoshowthatsmalltradesbyretailinvestorshaveverylittleinformationcontent,andindeed,weﬁnd

thatsuchtradestendtosufferfromimmediateshort-termlosses.Ourresultsonindividualtraders

areconsistentwiththeevidenceontheTaiwanstockmarketprovidedbyBarberetal.(2009),where

retailinvestorswerefoundtosuffersubstantialtradinglosses.

5.5. Choiceofordertypesbyinformedtraders

Anothertradingdecisionwhichhastobemadebyinformedtradersintheoptionsmarketisthe

choicebetweenmarketordersandlimitorders.Underthetraditionalview,theassumptionisthat

informedtraderswillplacemarketordersonly,essentiallybecausetheimmediacyoftheseorders

allowssuchinformedtraderstotakeuptheirpositionsbeforetheirinformationleaksout(Rock,1990;

19_As_regards_evidence_on_the_stock_markets,_Barclay_et_al.₍₁₉₉₃₎_found_that_medium-sized_trades_accounted_for_an_estimated

92.8percentofthecumulativepricechangeduringpre-tenderofferannouncementperiods;Chakravarty(2001)notedthat informativetradesontheNYSEwerealmostentirelyattributabletothemedium-sizedtradesinitiatedbyinstitutions;and AlexanderandPeterson(2007)providedfurtherevidenceofincreasedclusteringofmedium-sizedtradesontheNYSEand Nasdaq,whichtendedtohavegreaterpriceimpactthanlargeroundedtrades.Theﬁrstevidenceonderivativesmarketswas presentedbyAnandandChakravarty(2007),whodocumentedapreferenceamongstinformedtradersformedium-sizedtrades inequityoptions.

Informed trading, trading strategies and the information content of trading volume: Evidence from the Taiwan index options market

Journal

of

International

Financial

Markets,

Institutions

&

Money

Informed

trading,

trading

strategies

and

the

information

content

of

trading

volume:

Evidence

from

the

Taiwan

index

options

market

Wen-liang

G.

Hsieh

,

Huei-Ru

He

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