LEAPS of Faith : A Trading Indicator Based on CBOE S&P 500 LEAPS Option Open Interest Information

A long standing debate has revolved around the question of whether information travels first to the stock market or to the stock options market. Using an open interest based predictor calculated from CBOE S&P 500 LEAPS options, we find evidence of strong predictive power from the options market on the underlying S&P 500 index. This evidence is supported by out-of-sample tests of a simple trading strategy using the open interest based predictor as a trading indicator. We illustrate the practical application of this strategy for an active manager using exchange traded funds with a variety of leverage and shorting constraints. The trading indicator is also shown to be useful for a semi-active manager employing enhanced indexing techniques