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Journal of Banking & Finance Vol. 36 No. 9 2012

Derivatives traders’ reaction to mispricing in the underlying equity

Darren K. Hayunga1,2; Richard Holowczak3,4; Peter P. Lung2,5; Takeshi Nishikawa6,5

1 University of Georgia · 2 The University of Texas at Arlington · 3 Baruch College · 4 City University of New York · 5 University of Denver · 6 University of Colorado Denver

Abstract

This article examines trading behavior in the options market conditioned on mispricing in the underlying stock. We investigate the price equilibrium between the observed equity asset and the options-implied synthetic share as well as the relative divergence between the two prices. We find a consistently positive relation between the level of stock mispricing and violations of the upper-boundary condition using derivatives, along with an increase in price divergence. To control for the effect of shorting limitations on mispricing, we further examine prices during the short-sale ban in 2008. The results hold and in many instances are more significant during the ban period. Given the persistent disequilibria between the synthetic and observed stock prices, we argue the results are evidence of informed trading in the derivatives market.

DOI
10.1016/j.jbankfin.2012.04.018
Volume
36
Issue
9
Pages
2438-2454
Language
en
Sources
openalex crossref bibtex:phds-export.bib

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