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Can options volume affect the underlying asset price indirectly? I know that options buying/selling does not directly affect the price of the underlying asset (rather, the asset price contributes most to the option price). I do know of technical studies and alert systems that factor in options volume, and put/call ratios, but outside of some speculation, is there a known school of thought which revalues an asset based on the desirability of its options?

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I recall an article from Technical Analysis of Stocks & Commodities that described a phenomenon on the closing price of the stock an expiration day as being affected by the volume of puts and calls. One of the author's main points was that the stock price would end up at the place that would cause the maximum loss for the option purchasers (as an aggregate). I would think that the exercise of the option might cause some movement toward an exercise price. –  rajah9 Nov 11 '11 at 4:22
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I also recall a case where a court placed docs about a decision concerning a large computer company. While the court did not make the link public before the close of trading that day, some industrious folks figured out what the URL would be, read the documents, and bought a lot of options to speculate on the direction of the company once the link became officially public. Maybe this is not so much option volume as dramatic change in option volume that does not change the price of the asset but rather predicts what the price will do. –  rajah9 Nov 11 '11 at 4:26
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1 Answer

Nearly every options trader - and every options marketmaker - will hedge their derivatives exposure by trading the underlying.

So even if I buy a set of naked calls, my counterparty (e.g. whoever is writing me the options, usually a hedge fund or a bank) will have negative exposure to the stock and buy it to cancel out their risk.

Think of an option as something with a certain probability of turning into a stock and a certain probability of turning into nothingness. The delta is a rough estimate of "how much of a stock is it right now" - a 0.5 delta option behaves 50% like the underlying stock. If I buy a near-delta 1 option (e.g. extremely in the money, short expiry), then I've just bought the stock. In an efficient market that should flow through to affect the price of the stock itself.

It's theoretically possible for this not to be the case - my cousin writes me a call option on MSFT, we treat it as a side bet on the price of the stock, and we never think about it again until the decision/expiry date - but that doesn't happen in the real world.

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I am familiar with pinning, but I do guess that some players hedge with the underlying stock. –  CQM Nov 12 '11 at 12:23
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Nearly all players hedge with underlying stock. –  YGA Nov 17 '11 at 1:50
    
Btw, if you hedge with the underlying yourself, then the effects of your broker's hedging should cancel out with yours - though of course you will be using slightly different models, rehedging with different frequencies, etc. –  YGA Nov 17 '11 at 1:51
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