Equity Funds and Options Price Information
Explore how equity funds utilize options price information to enhance stock trades, the challenges of regulatory compliance in options trading, and the impact of options markets on stock price discovery. Research findings suggest a potential for profitable trades by leveraging options data in equity fund strategies.
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Presentation Transcript
Do Mutual Funds Exploit Information from Options Prices for Equity Investment? Konan Chan National Chengchi University Hsiu-Lang Chen University of Illinois at Chicago Pei-Shan Tung National Chengchi University R/Finance Conference 2016
Options Trading Contributes to Stock Price Discovery Are options markets more attractive to informed traders? Higher leverage available in options markets Short-sale costs in equity markets 2
Options Trading Contributes to Stock Price Discovery Cremers and Weinbaum (2010): Deviations from put-call parity (Spread) Xing, Zhang, and Zhao (2010): Volatility skew in stock options (Skew) Johnson and So (2012): Options trading volume/stock trading volume (O/S) 3
Why do few equity funds actually trade options? Almazan, Brown, Carlson, and Chapman (2004): 9.6% of funds that are allowed to trade options actually do it Cici and Palacios (2015):About 10% of funds use options at least once Non-trivial regulatory compliance cost 4
Non-trivial Regulatory Compliance Cost of Trading Options by Funds Disclosure of options use Section 17(f) of the 1940 Act on the collateral requirement Section 18(f) of the 1940 Act on the asset coverage requirement Diversification Test by IRS 5
Do equity funds exploit the options price information to make profitable individual stock trades? the regulatory compliance for using options by mutual funds is cumbersome the restriction on stock trading is less 6
Empirical Design Re-examine the predictability of the underlying stock returns by 3 options variables: Spread, O/S, and Skew Compare optioned stocks in two universes: CRSP stocks versus stocks held by US equity funds Sort stocks into deciles according to a stock s Spread Similar SIZE & B/M of optioned stocks The 4-factor alpha on the hedge portfolio (D10 D1) for stocks in the CRSP universe is 61 bps. It is stronger for stocks in fund holdings. 7
Do Mutual Funds Profit from the Options Price Information? For each equity fund portfolio, calculate VW-Spread Sort funds into quintiles quarterly by VW-Spread Quintiles are held for the following 3 months. The 4-factor alpha based on the net-of-expense fund returns for the hedge portfolio (Q5-Q1) is 33 bps. 8
