Differences in trading and pricing between stock and index options

Michael Lemmon, Sophie Xiaoyan Ni

Research output: Contribution to journalJournal articlepeer-review

27 Citations (Scopus)


We find that the demand for stock options that increases exposure to the underlying is positively related to the individual investor sentiments and past market returns, whereas the demand for index options is invariant to these factors. These differences in trading patterns are also reflected in the differences in the composition of traders with different types of options-options on stocks are actively traded by individual investors, whereas trades in index options are more often motivated by the hedging demand of sophisticated investors. Consistent with a demand-based view of option pricing, the individual investor sentiments and past market returns are related to time-series variations in the slope of the implied volatility smile of stock options, but they have little impact on the prices of index options. The pricing impact is more pronounced in options with a higher concentration of unsophisticated investors and those with higher delta hedging costs. Our results provide evidence that factors not related to fundamentals also impact security prices.

Original languageEnglish
Pages (from-to)1985-2001
Number of pages17
JournalManagement Science
Issue number8
Early online date26 Mar 2014
Publication statusPublished - Aug 2014

Scopus Subject Areas

  • Strategy and Management
  • Management Science and Operations Research

User-Defined Keywords

  • options
  • volatility smile
  • sentiment
  • speculation
  • behavior


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