Option Market Liquidity: Commonality and Other Characteristics

Melanie Cao, Jason Zhanshun Wei
2008 Social Science Research Network  
This study examines the option market liquidity using Ivy DB's OptionMetrics data. We establish convincing evidence of commonality for various liquidity measures based on the bid-ask spread, volumes and price impact. The commonality remains strong even after controlling for the underlying stock market's liquidity and other liquidity determinants such as volatility. Smaller firms and firms with a higher volatility exhibit stronger commonalities in option liquidity. Aside from commonality, we
more » ... commonality, we also uncover several other important properties of the option market's liquidity. First, information asymmetry plays a much more dominant role than inventory risk as a fundamental driving force of liquidity. Second, the market-wide option liquidity is closely linked to the underlying stock market's movements. Specifically, the options liquidity responds asymmetrically to upward and downward market movements, with calls reacting more in up markets and puts reacting more in down markets.
doi:10.2139/ssrn.1082642 fatcat:l5dwupxtibhjxeyajbjemce2ou