Working Paper: NBER ID: w10264
Authors: Josef Lakonishok; Inmoo Lee; Allen M. Poteshman
Abstract: This paper investigates the behavior of investors in the equity option market using a unique and detailed dataset of open interest and volume for all contracts listed on the Chicago Board Options Exchange over the 1990 through 2001 period. We document major stylized facts about the option market activity of three types of non-market maker investors over this time period and also investigate how their trading changed during the stock market bubble of the late 1990s and early 2000. Our key findings are: (1) non-market maker investors have about four times more long call than long put open interest, (2) these investors have more short than long open interest in both calls and puts, (3) each type of investor purchases more calls to open brand new positions when the return on underlying stocks are higher over horizons ranging from one week to two years into the past, (4) the least sophisticated group of investors substantially increased their purchases of calls on growth but not value stocks during the stock market bubble of the late 1990s and early 2000, and (5) none of the investor groups significantly increased their purchases of puts during the bubble period in order to overcome short sales constraints in the stock market.
Keywords: Investor Behavior; Option Market; Equity Options; Market Bubble
JEL Codes: G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Behavioral biases (D91) | Elevated levels of short call open interest (G13) |
| Behavioral biases (D91) | Trend-chasing behavior (C92) |
| Investor groups (G24) | Lack of appetite for hedging against downturns (G40) |
| Higher past returns (G17) | Increased buying of call options (G13) |
| Higher past returns (G17) | Volume of new call purchases (G24) |
| Less sophisticated investors (G19) | Increased purchases of calls on growth stocks (G19) |
| Increased purchases of calls (G19) | Preference for calls among nonmarket maker investors (G19) |