Derivatives Traders’ Reaction to Mispricing in the Underlying Equity

17 Pages Posted: 14 Jun 2010 Last revised: 26 Jul 2012

See all articles by Darren K. Hayunga

Darren K. Hayunga

University of Georgia - Department of Insurance, Legal Studies, Real Estate

Richard Holowczak

City University of New York (CUNY) - Paul H. Chook Department of Information Systems & Statistics

Peter P. Lung

University of Texas at Arlington

Takeshi Nishikawa

University of Colorado at Denver

Date Written: April 1, 2012

Abstract

This article examines trading behavior in the options market conditioned on mispricing in the underlying stock. We investigate the price equilibrium between the observed equity asset and the options-implied synthetic share as well as the relative divergence between the two prices. We find a consistently positive relation between the level of stock mispricing and violations of the upper-boundary condition using derivatives, along with an increase in price divergence. To control for the effect of shorting limitations on mispricing, we further examine prices during the short-sale ban in 2008. The results hold and in many instances are more significant during the ban period. Given the persistent disequilibria between the synthetic and observed stock prices, we argue the results are evidence of informed trading in the derivatives market.

Keywords: Options pricing, Short-Sale constraints, Heterogeneous beliefs, Stock overpricing

JEL Classification: G11, G12, G13, G14

Suggested Citation

Hayunga, Darren K. and Holowczak, Richard and Lung, Peter P. and Nishikawa, Takeshi, Derivatives Traders’ Reaction to Mispricing in the Underlying Equity (April 1, 2012). Journal of Banking and Finance, Vol. 36, No. 9, 2438–2454, 2012, Available at SSRN: https://ssrn.com/abstract=1623976

Darren K. Hayunga (Contact Author)

University of Georgia - Department of Insurance, Legal Studies, Real Estate ( email )

Athens, GA 30602-6254
United States
706-542-1365 (Phone)

Richard Holowczak

City University of New York (CUNY) - Paul H. Chook Department of Information Systems & Statistics ( email )

17 Lexington Avenue
New York, NY 10010
United States
646-312-1544 (Phone)
646-3121541 (Fax)

HOME PAGE: http://cisnet.baruch.cuny.edu/holowczak/

Peter P. Lung

University of Texas at Arlington ( email )

415 S West St Apt no 205
Arlington, TX 76019
United States

Takeshi Nishikawa

University of Colorado at Denver ( email )

Box 173364
1250 14th Street
Denver, CO 80217
United States

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