The Economics of Option Trading

Abstract

An option provides a bundle of economic characteristics, including leverage, exposure to the underlying asset, exposure to a particular dynamic trading strategy, and exposure to volatility and jumps. The wide variety of options traded on indexes and large stocks permits investors to select the particular economic characteristics of interest when buying and selling options. We group exchange-traded equity and index options into delta- and maturity-based buckets, which provide dierential exposure to these economic characteristics. We examine the determinants of volume, signed volume, open interest, and gamma volume for these buckets. Option activity is concentrated in out-of-the-money and at-themoney options for both individual stocks and indexes. Equity option activity is aected strongly by volume in the underlying asset, earnings announcements and dividend payments. We nd that earnings announcements in particular generate substantial increases in volume, no increase in open interest, and additional exposure for market-makers, suggesting that traders are using market-makers to facilitate a common strategy that is long gamma.