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Liquidity and Price Informativeness of Options: Evidence From Extended Trading Hours

Journal: Journal of Futures Markets

Date: 2025

Author: Liangyi Mu, Arie E. Gozluklu

Abstract:
This paper explores the trading dynamics of the options market during extended trading hours (ETHs). During ETH, the options market is characterized by low liquidity and decreased trading activities, yet there is an increased likelihood of informed trading. The introduction of ETH improves overall market liquidity on the following trading day, as reflected by a reduction in the quoted and effective bid–ask spreads, for both index options and their underlying constituents. The improvement of liquidity is due to the timely incorporation of overnight news into option prices during ETH. Moreover, option prices during ETH are informative for the index level and realized volatility in the subsequent regular trading hours.

Link: Google Scholar

Background and Context

Market Innovation

In 2015, the Chicago Board Options Exchange introduced extended trading hours (3:00 AM - 9:15 AM) for S&P 500 index options, creating a natural experiment to study market effects.

Research Design

The study uses difference-in-differences analysis comparing S&P 500 weekly options (SPXW) with extended hours against S&P 500 ETF options (SPY) without extended hours as a control group.

Data and Methodology

Analysis covers December 2014 to May 2015 using high-frequency options data from Refinitiv DataScope, examining bid-ask spreads, adverse selection, and price informativeness measures.

Extended Hours Show Higher Trading Costs But Enable Better Price Discovery

Extended Hours 3:00 AM - 9:15 AM Higher Costs: Quoted Spread: $2.03 Effective Spread: $1.40 Benefits: News Integration Price Discovery Informed Trading Regular Hours 9:30 AM - 4:15 PM Lower Costs: Quoted Spread: $1.01 Effective Spread: $0.30 Improvements: Better Liquidity Reduced Asymmetry
  • Extended trading hours feature significantly higher bid-ask spreads due to lower liquidity and fewer market participants.
  • Despite higher costs, ETH enables timely incorporation of overnight news and informed trading activity.
  • The benefits of ETH spillover to regular hours, improving overall market quality and reducing information asymmetry.

Extended Hours Introduction Significantly Reduced Bid-Ask Spreads During Regular Trading

  • SPXW options with extended hours saw bid-ask spreads fall by $0.15 after ETH introduction.
  • Control group SPY options without extended hours showed minimal change, validating the treatment effect.
  • The difference-in-differences result confirms ETH directly caused the liquidity improvement in regular trading hours.

Information Asymmetry Costs Declined Substantially After Extended Hours Launch

  • Adverse selection measures capturing information asymmetry fell by 0.15 percentage points for SPXW options.
  • Control group SPY options showed no meaningful change in adverse selection costs during this period.
  • Lower information asymmetry indicates more efficient price discovery and reduced trading costs for all participants.

Extended Hours Enable Timely Integration of Overnight News and Market Information

Overnight News European Markets Corporate Earnings Macro Announcements ETH Processing 3:00 - 9:15 AM Price Incorporation Informed Trading Regular Hours 9:30 AM - 4:15 PM Improved Liquidity Lower Asymmetry 4:15 PM 3:00 AM 9:15 AM 4:15 PM Overnight Extended Hours Regular Trading
  • Extended hours provide a crucial window for processing overnight information from global markets and corporate news.
  • Research shows significantly higher bid-ask spreads during macroeconomic announcements at 8:30 AM during ETH.
  • By incorporating news during ETH, regular trading hours begin with more efficient prices and reduced uncertainty.

S&P 500 Index Constituents Experienced Substantial Liquidity Improvements

  • S&P 500 constituent stocks saw quoted spreads fall by 0.95 cents after options ETH introduction.
  • Control group S&P 400 stocks showed minimal change, confirming the spillover effect was ETH-specific.
  • The liquidity improvement demonstrates how derivatives market innovations can benefit underlying asset markets significantly.

Contribution and Implications

  • First comprehensive study of options market microstructure during extended trading hours provides new empirical insights.
  • Extended hours improve overall market quality despite appearing to have lower liquidity during those periods.
  • Findings support expanding extended hours to other derivatives markets to enhance price discovery mechanisms.
  • Results demonstrate how market structure innovations can create positive externalities for underlying asset liquidity.
  • Policy implications suggest benefits of allowing more trading flexibility outweigh concerns about fragmented liquidity.

Data Sources

  • Visualization 1 constructed using summary statistics from Table 3 comparing trading costs in extended versus regular hours.
  • Visualization 2 uses difference-in-differences results from Table 4 Panel A showing bid-ask spread changes around ETH introduction.
  • Visualization 3 based on adverse selection measures from Table 5 Panel A demonstrating information asymmetry reduction.
  • Visualization 4 illustrates news incorporation process described in Section 5.2 and supported by Figure 1 intraday patterns.
  • Visualization 5 uses index constituent liquidity data from Table 7 Panel A showing spillover effects to underlying stocks.