This study directly tests the ability of several competing methods to identify market buy and sell orders using intra-day quote and trade prices, and identifies factors that affect the accuracy of the methods. Lee and Ready's (1991) algorithm performs about the same as the tick test, but the performance of both methods is worse than expected. The results show that the use of either algorithm to classify trades can lead to significantly biased estimates of effective spreads and signed volume, but the tick test provides better estimates of effective spreads and signed volume than Lee and Ready's method. I. Introduction The use of intra-day prices in empirical studies of securities markets is increasingly common and studies frequently require trades be identified as buyer or seller initiated. Unfortunately, most data sets do not identify trade direction. Methods have, however, been proposed that allow trade direction to be inferred from adjacent prices and quotes. The accuracy of these methods and the implica? tions for microstructure research are still unresolved issues in large part because trade direction is unobservable in most financial data sets. This study directly tests the ability of several competing methods to iden? tify market buy and sell orders using intra-day quote and trade prices. The tests are conducted using the TORQ database, a unique data set the New York Stock Exchange makes available to researchers that contains information on trades, quotes, and orders. Using the tick tests and Lee and Ready's (LR hereafter) (1991) method to classify trades as buys or sells, and comparing the results to the direction of the actual orders, I directly test the accuracy of the classification algorithms. The tests also identify the factors that affect the accuracy of the clas? sification methods. Additional tests demonstrate that using these algorithms can lead to biased inferences in two of their most common applications: estimating effective spreads and signed volume trading. Test results also show that the tick

This study examines the hypothesis that in the presence of market frictions, relative put and call prices contain information concerning future returns of the underlying asset. A measure of relative prices is derived from the put-call parity relationship for index options and applied to a three-year sample of OEX option transactions. The results show that the measure of relative index option prices leads the stock market by at least 15 minutes.

Thomas J. Finucane, Black-Scholes Approximations of Call Option Prices With Stochastic Volatilities: A Note, The Journal of Financial and Quantitative Analysis, Vol. 24, No. 4 (Dec., 1989), pp. 527-532

This study tests the hypothesis that common stock call options are exercised rationally and in accordance with the commonly used frictionless markets boundary conditions. Using two years of historical early exercise data for common stock call options, the results show that contrary to the frictionless markets boundary conditions, approximately 20 percent of the early call exercise occurs at times other than ex-dividend dates. While most of the non-dividend related early exercise may be explained by transactions costs, a significant number of contracts appear to be exercised irrationally. These results suggest that failure to incorporate market frictions in option pricing models is likely to lead to specification error.

This study provides a comprehensive empirical analysis of the early exercise history of S&P 100 put and call option. Even though the S&P 100 index option market is generally considered to be the most efficient options market in the world, we show that many exercise decisions are inefficient because they occur when recorded bids are greater than exercise values. Due to market imperfections, some of the cases of inefficient exercise are still rational, but we show that a substantial number of these decisions are clearly irrational since it would have been possible to realize a larger riskless net cash flow by selling. Unlike previous studies of early exercise, our tests of efficiency and the rational decisions that presumably lead to efficient markets are model independent. We also provide evidence concerning the relative significance of dividends and the wild card to index option pricing models, and introduce and document the importance of the option to exercise and avoid the indirect costs of the spread. We also find evidence of a significant day-of the-week exercise effect, and present some likely explanations for that effect.

[This study provides a comprehensive empirical analysis of the early exercise history of S&P 100 put and call options. Even though the S&P 100 index options market is generally considered to be the most efficient options market in the world, we show that many exercise decisions are inefficient because they occur when recorded bids are greater than exercise values. Due to market imperfections, some of the cases of inefficient exercise are still rational, but we show that a substantial number of these decisions are clearly irrational, since it would have been possible to realize a larger riskless net cash flow by selling. Unlike previous studies of early exercise, our tests of efficiency and the rational decisions that presumably lead to efficiency markets are model independent. We also provide evidence concerning the relative significance of dividends and the wild card to index option pricing models, and introduce and document the importance of the option to exercise and avoid the indirect costs of the spread. We also find evidence of a significant day-of-the-week exercise effect, and present some likely explanations for that effect.]