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August 13, 2006
Options Traders and Mary Hart
While option traders often get a bad rap as risk-seeking crazies with the attention span of Mary Hart, a paper summarized in today's Times shows how an option piggy-back strategy turns in impressive numbers. Assuming you have the size and can therefore deal with high portfolio turnover, a naive volume-following option strategy turned in 50% annualized returns over the last fifteen years:We present strong evidence that option trading volume contains information about future stock price movements. Taking advantage of a unique dataset from the Chicago Board Options Exchange, we construct put-call ratios from option volume initiated by buyers to open new positions. On a risk-adjusted basis, stocks with low put-call ratios outperform stocks with high put-call ratios by more than 40 basis points on the next day and more than 1% over the next week. Partitioning our option signals into components that are publicly and non-publicly observable, we find that the economic source of this predictability is non-public information possessed by option traders rather than market inefficiency. We also find greater predictability from option signals for stocks with higher concentrations of informed traders and from option contracts with greater leverage.
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I think you will find that options order flow is much less "informed" since the implementation of Reg FD. As a career options trader, the likelihood of getting "picked-off" by informed buyer has fallen dramatically.
ELAINE: Hey, hey, wait a minute! Let me ask you something. Kramer, the last time you hit your head, was Mary Hart on TV?
KRAMER: Yeah.
(Elaine claps her hands together then stands up)
ELAINE: That is it!
KRAMER: What?
(Elaine walks toward Kramer pointing her finger at him)
ELAINE: That is it! Mary Hart's voice, don't you see? There's something about Mary Hart's voice that's giving you seizures. Just like, just like, just like that woman in Albany!
(George walks out of Jerry's bedroom toward kitchen, Kramer sits down)
KRAMER: Mary Hart!
(source: http://www.seinology.com/scripts/script-37.shtml)
If you take a look at the paper
http://www.business.uiuc.edu/poteshma/WorkingPapers/WorkingPapers.htm
it doesn't really say what Hulbert suggests. It looks like the authors focus on buying by hedge funds in out of the money options. Not just the gross put/call ratio.