Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?

This paper examines the relation between net buying pressure and the shape of the implied volatility function (IVF) for index and individual stock options. We find that changes in implied volatility are directly related to net buying pressure from public order flow. We also find that changes in impl...

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Bibliographic Details
Published in:The Journal of finance (New York) 2004-04, Vol.59 (2), p.711-753
Main Authors: Bollen, Nicolas P. B., Whaley, Robert E.
Format: Article
Language:English
Subjects:
Arbitrage
ATMs
Call options
Correlation analysis
Dividends
Financial portfolios
Market prices
Price volatility
Stock market indices
Stock options
Stock prices
Studies
Supply & demand
Volatility
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Summary:This paper examines the relation between net buying pressure and the shape of the implied volatility function (IVF) for index and individual stock options. We find that changes in implied volatility are directly related to net buying pressure from public order flow. We also find that changes in implied volatility of S&P 500 options are most strongly affected by buying pressure for index puts, while changes in implied volatility of stock options are dominated by call option demand. Simulated delta-neutral option-writing trading strategies generate abnormal returns that match the deviations of the IVFs above realized historical return volatilities.
ISSN:0022-1082
1540-6261
DOI:10.1111/j.1540-6261.2004.00647.x