This paper investigates informed trading on stock volatility in the option market. We construct non‐market maker net demand for volatility from the trading volume of individual equity options and find that this demand is informative about the future realized volatility of underlying stocks. We also find that the impact of volatility demand on option prices is positive. More importantly, the price impact increases by 40% as informational asymmetry about stock volatility intensifies in the days leading up to earnings announcements and diminishes to its normal level soon after the volatility uncertainty is resolved.

The question of whether and to what extent option trading affects underlying stock prices has been of interest to researchers since exchange-based options trading began in 1973. Recent research presents evidence of an informational channel through which option trading affects stock prices by showing that option market makers’ stock trades to hedge new options positions cause the information reflected in option trading to be impounded into underlying equity prices. This paper provides evidence of a noninformational channel through which option market maker hedge rebalancing affects stock return volatility and the probability of large stock price moves.