Using Option Quotes and Trades to Assess Implied Volatility and Information
Summary
The document compares option quote data with executed transactions as sources of information about implied volatility. Quotes show prices and volatility levels at which participants are willing to trade, including times when no opposing order arrives. Trades show that an order was actually matched; when a trade and quote share a timestamp, an aggressive participant has crossed the spread to trade against resting liquidity.
The response explains why researchers often treat aggressive trades as potentially informed: willingness to pay the spread may reflect a belief that the displayed price is attractive. This is an interpretation, not proof that a trader possesses superior information, and the trade price also reflects the spread and trade direction. A second answer suggests calculating transaction implied volatility with buy or sell direction and comparing it with contemporaneous displayed markets, while accounting for time elapsed and movement in the underlying. Listed and over-the-counter options may require different comparisons.
Key ideas
- Quotes record displayed willingness to trade, while executions confirm that a buyer and seller matched.
- An aggressive trade pays the spread against resting liquidity and may carry information about the trader’s view.
- Trade direction and the distance from the midpoint affect the implied volatility inferred from an execution.
- Comparisons between transaction and quoted implied volatility should account for elapsed time and underlying price moves.
- The interpretation of transaction data can differ between listed and over-the-counter options.
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# Option quotes or trades: Which one is more informative? # Option quotes or trades: Which one is more informative? Suppose I have quote data as well as real transaction of option contracts? I was wondering if the informational content is the same. On the first hand, quotes show the intention of seller/buyers on the price, but on the other trades show realization of these intentions. Are there any differences between the implies volatility retrieved from quotes or trades? ## Answer by Fr1 (score 1, accepted) https://quant.stackexchange.com/a/46963 I will try to be as concise as possible. For obvious reasons, if you do not have any trades, choose the quotes, because they reflect the intention of a player to trade at that level of price/implied_vol at a certain point in time (where we have no trades because those quotes are not matched by other traders). If instead you have a quote and a trade referred to the same timestamp, it means that, at that time, there was a trade initiator (aggressive buyer/seller) that decided to trade against a passive quotes resting on the book of the instrument (posted by another market participant, let's suppose a market maker). In financial literature, very often those aggressive trades are considered "informed trades" because they reflect the intention of a player to pay the spread implicit in the quote posted by the market maker (this holds for options as well as equities as well as for any other instrument having a book). You can search the literature for "aggressive, informed trades" and you will find plenty of things.. this is just one of the several examples (read about aggressive trades). The intuitive reason is that, if a market player wishes to trade actively and pay the spread to a market maker, then it means that this aggressive trader has some kind of information allowing him to say that the quote posted is "convenient" and "cheap". Clearly, the difference between the traded price and the initial quote matched is just a function of the spread that the trader is paying to the market maker: but, if someone is willing to actively pay for that spread, it is rational to believe that there is a reason for this (i.e. the active trader has some information to accept to pay the spread in the form of "higher-than-midpoint" price/implied_vol if the trader is buying or "lower-than-midpoint" price/implied_vol if the trader is selling). This is the point. For further clarity, take this reasoning to the extreme, and consider the theoretical (and often academic) example of an informed trader that has some inside information: that trader is highly informed and will be willing to accept any kind of price/implied_vol up to the level where the price/implied_vol will fully reflect that information and thus the trader will be neutral to trade or not to trade. Assuming that the trader reaches that point and trades at that price, then the price/implied_vol will reflect the information owned by that highly informed trader that initiated the trade (generating some adverse selection against the "less informed" market maker that posted the quote, indeed you can also search the literature for adverse selection on passive traders or market makers). ## Answer by Edward Watson (score 1) https://quant.stackexchange.com/a/46962 It's a little dependent on whether its listed or otc options but your question about implied volatilities probably addresses the issue the best. I would calculate the implied volatility from the real transactions noting whether its a buy or sell and then do the same for the markets that you are seeing and compare them depending on what the market has done since then. Unless it's been a long time or the underlying has moved a lot the transactions should be a good guide for vol. If they're listed and your buying and the transactional vol is lower than what the ask in the screens is, try for a lower price at that vol and see what happens. If it's otc, keep in mind the transaction data and compare it to what multiple dealers come back to you with and use those transaction vols to negotiate.
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