ROCHESTER, N.Y., Dec. 8, 2015 (GLOBE NEWSWIRE) -- The average stock investor will buy a promising stock and hope to sell it later for a higher price. However, for short to medium-term investors, options can offer a better investment than stocks for traders seeking to exploit informational advantages. But do options investors really exploit all the advantages of public information?
Not according to new research from the Simon Business School at the University of Rochester, which reveals that options traders tend to underreact to publically available information.
"Based on our research, we've found that there's mispricing occurring in the equity market," said Bryce Schonberger, assistant professor of accounting from Simon Business School and co-author of the study. "Investors appear to systemically underreact to certain pieces of information. Normally, we would expect sophisticated investors who participate in the options market to process information efficiently, but we actually see the opposite."
Accumulating Evidence
The researchers analyzed a sample of 76,391 firm-quarters over the 1995-2011 period comprising 4,119 distinct firms with actively traded exchange-listed options. They studied whether options prices incorporated in a timely manner can predict patterns in future stock returns arising from four well-documented accounting-based trade anomalies, which include:
* Post–earnings-announcement drift (PEAD): The tendency for a stock's cumulative abnormal returns to drift in the direction of an earnings surprise for several weeks or months following an earnings announcement.
* Accrual anomaly: One of the most persistent stock market inefficiencies ever identified, which found that shares in companies with small or negative accrual ratios vastly outperform those of companies with large ones.
* Net Operating Assets (NOA): A measure of the extent to which operating/reporting outcomes provoke excessive investor optimism.
* Change in NOA turnover: The ratio of the value of a company's sales or revenues generated relative to the value of its assets and is often used as an indicator of the efficiency with which a company is deploying its assets in generating revenue.
The results suggest that while it is not possible to exploit these anomalies through purchasing options, various strategies that involve writing (selling) options provide limited opportunities to earn significant returns over a 90-day period. Overall, the research shows that the options process exhibits the exact forms of mispricing by stock prices, suggesting that options markets are no more efficient processors of information than stock markets with regard to processing public accounting information.
About Simon Business School
The Simon Business School is currently ranked among the leading graduate business schools in the world in rankings published by the popular press, including Bloomberg Businessweek, U.S. News & World Report, and the Financial Times. The Financial Times recently rated the School No. 3 in the world of economics and No. 5 in the world for finance. More information about Simon Business School is available at www.simon.rochester.edu.