The Relationship between Option Trading Intensity and the Market Microstructure of the Underlying Security

This paper examines the differences in stock market volume, volatility and quotes during intervals in which options trade versus periods in which options do not trade. We find that options trade when the stock market is active and volatile. However, there is a negative relationship between short run volatility and option trading intensity. Also, bid-ask spreads are higher and the depth of the quotes is lower when options trade. This is partially because the probability of a transaction occurring within the spread and the autocorrelation between successive price changes is higher in option trading times, but this deterioration in quotes is not accompanied by an increase in adverse selection or inventory costs and needs further investigation