Cost Reduction, Informational Efficiency, and Prices of Options

Abstract

This paper documents four findings in the option market based on two stages of decimalization where switching control and treatment stocks is possible. First, uninformed traders are more cost sensitive than informed traders. Second, the paper proves and verifies that when uninformed traders are more cost sensitive, trading cost reduction causes slower response of price to information. Those findings are contrary to the evidences in the stock market. Third, decimalization narrows bid ask spread, increases volume, and deepens depth, especially for options requiring frequent hedging re-balancing in the stock market. Finally, option prices become more expensive after decimalization.

Keywords: Derivatives, Options, Information Efficiency, Transaction Costs