The Informational Content of High-Frequency Option Prices

Most asset prices exhibit volatile and unexpected movements. Some of these fluctuations are due to sudden corrections—jumps—whereas others are associated with increases in the diffusive, transitory volatility. It is, however, challenging to separate the diffusive portion of volatility from its jump component as there is no direct measure of volatility—it is latent. This study investigates these two components using different datasets.

Historically, estimation of such quantities relied on (low-frequency) daily returns—using one observation per day. Nowadays, however, returns over smaller—intraday—time steps are also available. For more than a decade now, researchers in the field of finance and econometrics have used so-called high-frequency asset returns to measure financial risk more accurately and understand this breakdown.

In addition to these low- and high-frequency asset returns, there is a whole array of options being traded every day. These options can be seen as insurance contracts on the asset itself: a premium must be paid on purchase to have the right to exercise the option at maturity. Their premiums depend on the risk associated with the embedded insurance. Including the price of various options in our sample therefore helps us identify the unobservable variables’ behaviour—volatility and jumps. Indeed, many studies are already doing this using end-of-day option prices. However, very few studies used intraday variations in options because doing so increases the sample size considerably and appreciably amplifies the computational issues involved in estimating model parameters.

This study uses traditional observations (returns, intraday variations, and end-of-day option prices) and adds the intraday variations of option prices. We show that the informational content of high-frequency option prices allows us to gain more insight into the breakdown mentioned above. Besides, the model’s unobservable factors (volatility and jumps) are measured more precisely. Consequently, omitting the option intraday information might lead to suboptimal investor decisions.

(by Diego Amaya, Jean-François Bégin, and Geneviève Gauthier)