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Suppose I have quote data as well as real transaction of option contracts? I was wondering if the informational content is the same. On the first hand, quotes show the intention of seller/buyers on the price, but on the other trades show realization of these intentions.

Are there any differences between the implies volatility retrieved from quotes or trades?

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  • $\begingroup$ Agreed. Also, often the last known trade will be fairly old, the quote on the other hand will provide current information. $\endgroup$ – noob2 Jul 25 '19 at 9:08
  • $\begingroup$ If I have information of a trade executed at e.g 12:05:45 (hh:mm:ss) and quotes for the same time point, which one should I select? $\endgroup$ – alexbougias Jul 25 '19 at 10:06
  • $\begingroup$ Your question is perfectly valid for the underlying equity market as well, and I think it will be easier to find some academic research on quote vs trade information content there, since equity data is easier to obtain. $\endgroup$ – LazyCat Jul 25 '19 at 11:25
  • $\begingroup$ Well made statements! I think the differential between the two carries a lot of info as well. Also when you say quotes, there would be like a whole range of them and that itself carries a lot of information. But if we were to make a binary decision- which one is more informative -that would depend on the purpose for which the info is used. $\endgroup$ – Magic is in the chain Jul 25 '19 at 11:34
  • $\begingroup$ Quotes should denote the best bid and ask, respectively. Actually, the comparison I imply should be done in the same dimension. Depth of the limit order book should not be taken into account. Just Traded Price vs Best Bid/Ask $\endgroup$ – alexbougias Jul 25 '19 at 11:42
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I will try to be as concise as possible.

For obvious reasons, if you do not have any trades, choose the quotes, because they reflect the intention of a player to trade at that level of price/implied_vol at a certain point in time (where we have no trades because those quotes are not matched by other traders).

If instead you have a quote and a trade referred to the same timestamp, it means that, at that time, there was a trade initiator (aggressive buyer/seller) that decided to trade against a passive quotes resting on the book of the instrument (posted by another market participant, let's suppose a market maker). In financial literature, very often those aggressive trades are considered "informed trades" because they reflect the intention of a player to pay the spread implicit in the quote posted by the market maker (this holds for options as well as equities as well as for any other instrument having a book). You can search the literature for "aggressive, informed trades" and you will find plenty of things.. this is just one of the several examples (read about aggressive trades).

The intuitive reason is that, if a market player wishes to trade actively and pay the spread to a market maker, then it means that this aggressive trader has some kind of information allowing him to say that the quote posted is "convenient" and "cheap". Clearly, the difference between the traded price and the initial quote matched is just a function of the spread that the trader is paying to the market maker: but, if someone is willing to actively pay for that spread, it is rational to believe that there is a reason for this (i.e. the active trader has some information to accept to pay the spread in the form of "higher-than-midpoint" price/implied_vol if the trader is buying or "lower-than-midpoint" price/implied_vol if the trader is selling). This is the point.

For further clarity, take this reasoning to the extreme, and consider the theoretical (and often academic) example of an informed trader that has some inside information: that trader is highly informed and will be willing to accept any kind of price/implied_vol up to the level where the price/implied_vol will fully reflect that information and thus the trader will be neutral to trade or not to trade. Assuming that the trader reaches that point and trades at that price, then the price/implied_vol will reflect the information owned by that highly informed trader that initiated the trade (generating some adverse selection against the "less informed" market maker that posted the quote, indeed you can also search the literature for adverse selection on passive traders or market makers).

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  • $\begingroup$ I have only a set of trades and getting the quotes is quite time consuming. The microstructure explanation you gave seems good. $\endgroup$ – alexbougias Aug 5 '19 at 13:06
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    $\begingroup$ Exactly, it is a microstructure explanation.. without providing too many details on this, believe me if I tell you that I look at microstructure (and related literature) all the time :-) .. on this I think that, among the other authors, K. Malinova contributed a lot! $\endgroup$ – Fr1 Aug 5 '19 at 13:08
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It's a little dependent on whether its listed or otc options but your question about implied volatilities probably addresses the issue the best. I would calculate the implied volatility from the real transactions noting whether its a buy or sell and then do the same for the markets that you are seeing and compare them depending on what the market has done since then. Unless it's been a long time or the underlying has moved a lot the transactions should be a good guide for vol. If they're listed and your buying and the transactional vol is lower than what the ask in the screens is, try for a lower price at that vol and see what happens. If it's otc, keep in mind the transaction data and compare it to what multiple dealers come back to you with and use those transaction vols to negotiate.

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