Margin Rules, Informed Trading in Derivatives, and Price Dynamics

33 Pages Posted: 7 Nov 2008

See all articles by Kose John

Kose John

New York University (NYU) - Department of Finance

Apoorva Koticha

Northeastern University

Ranga Narayanan

Case Western Reserve University - Weatherhead School of Management

Marti G. Subrahmanyam

New York University (NYU) - Leonard N. Stern School of Business

Multiple version iconThere are 4 versions of this paper

Date Written: March 2000

Abstract

We analyze the impact of option trading and margin rules on the behavior of informed traders and on the microstructure of stock and option markets. In the absence of binding margin requirements, the introduction of an options market causes informed traders to exhibit a relative trading bias towards the stock because of its greater information sensitivity. In turn, this widens the stock'sbid-ask spread. But when informed traders are subject to margin requirements, their bias towards the stock is enhanced or mitigated depending on the leverage provided by the option relative to the stock, leading to wider or narrower stock bid-ask spreads. The introduction of option trading, with or without margin requirements, unambiguously improves the informational efficiency of stock prices. Margin rules improve market efficiency when stock and option margins are sufficiently large or small but not when they are of moderate size.

Suggested Citation

John, Kose and Koticha, Apoorva and Narayanan, Ranga and Subrahmanyam, Marti G., Margin Rules, Informed Trading in Derivatives, and Price Dynamics (March 2000). NYU Working Paper No. S-DRP-01-05, Available at SSRN: https://ssrn.com/abstract=1296433

Kose John (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)

Apoorva Koticha

Northeastern University ( email )

220 B RP
Boston, MA 02115
United States

Ranga Narayanan

Case Western Reserve University - Weatherhead School of Management ( email )

10900 Euclid Ave.
Dept. of Banking & Finance
Cleveland, OH 44106-7235
United States
216-368-2142 (Phone)

Marti G. Subrahmanyam

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

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