The impact of options introduction on the volatility of the underlying equities: evidence from the Chinese stock markets

Abstract

The impact of options introduction on the underlying equities has been a topic of interest for decades, but mixed conclusions have been obtained in various financial markets, using different sample periods and methodologies. This paper examines the impact of the introduction of SSE 50ETF options on the volatility of SSE 50ETF using four different GARCH family models. For all models, we consistently find a significant decrease of the underlying equity volatility after the options introduction, along with an improvement of information flow on the underlying equity price. Further analysis shows that the impacts of speculative and hedging option trading activities are asymmetric. While the unexpected hedging trading activities decrease the volatility of SSE 50ETF, the unexpected speculative trading activities increase the volatility. Our empirical findings based on Chinese financial markets support the theory that options introduction attracts informed traders, and improves the information flow and liquidity of the underlying equities, and consequently reduces their volatility.

Keywords:

• Options introduction
• Volatility
• SSE 50ETF
• GARCH-X models
• Realized GARCH models

Acknowledgements

We thank the discussants from the 7th International Conference on Futures and Other Derivatives (ICFOD 2018) for their useful comments and suggestions.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Thanks for the valuable suggestion from one of the referees.

Additional information

Funding

Chen acknowledges financial support from the National Nature Science Foundation of China [grant numbers #71571152; #71850011]. Liu acknowledges financial support from the National Nature Science Foundation of China [grant number #71761010], the National Nature Science Foundation of Hainan Province [grant number #718MS032]. Zhang acknowledges financial support from the Humanity and Social Science Youth Foundation of Chinese Ministry of Education [grant number #18YJC790210] and the Fundamental Research Fund for Central Universities [grant number #2722019PY038].