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substantial and pervasive influence of option trading on stock prices. ... A first strand of research on the impact of option trading on underlying stocks ...

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Does Option Trading Have a Pervasive Impact on Underlying Stock Prices?Page 1Does Option Trading Have a Pervasive Impact on Underlying Stock Prices?*Neil D. Pearson University of Illinois at UrbanaChampaign Allen M. Poteshman University of Illinois at UrbanaChampaign Joshua White University of Illinois at UrbanaChampaign January 17 2007 *Department of Finance College of Business University of Illinois at UrbanaChampaign 340 Wohlers Hall 1206 South Sixth Street Champaign IL 61820 (Phone: (217) 2440490 email: pearson2@uiuc.edu; phone: (217) 2650565 email: poteshma@uiuc.edu; and phone: (217) 2441166 email: jswhite@uiuc.edu.) We thank Joe LevinEileen Smith and Dick Thaler for assistance with the data used in this paper. We thank Michael Barclay Stewart Mayhew and seminar participants at CaseWestern Florida Illinois and Rochester for their helpful comments. Qian Deng provided excellent research assistance. We bear full responsibility for any remaining errors. Page 2Does Option Trading Have a Pervasive Impact on Underlying Stock Prices? ABSTRACT The question of whether and to what extent option trading impacts underlying stock prices has been a focus of intense interest since options began exchangebased trading in 1973. Despite considerable effort no convincing evidence for a pervasive impact has been produced. A recent strand of theoretical literature predicts that rebalancing by traders who hedge their option positions increases (decreases) underlying stock return volatility when these traders have net written (purchased) option positions. This paper tests this prediction and finds a statistically and economically significant negative relationship between stock return volatility and net purchased option positions of investors who are likely to hedge. Hence we provide the first evidence for a substantial and pervasive influence of option trading on stock prices. Page 31 1. Introduction Ever since individual equity options began trading in 1973 investors exchange ...

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