How Do Options Affect the Volatility of the Underlying Equity Market? Evidence from the Introduction of Weekly Options

This article investigates how options affect the volatility of the underlying equity market by using a quasi-natural experiment-the introduction of weekly options on individual stocks. The author examines the change in crash risk surrounding the introduction of weekly options by using a difference-in-difference approach that incorporates a control sample identified through propensity score matching. Among the six proxies for crash risk that are adopted, the extreme value theory (EVT)-based VaRs are better explained by the theoretically important determinant factors proposed in prior studies. However, no measure of the EVT-based VaR is significantly affected by the introduction of weekly options. The other four measures of crash risk, which are extensively used in prior studies, are not adequately explained by the proposed determinants and they do not become significantly higher for the optioned stocks following the introduction of weekly options. The author uses machine-learning methods, such as a regression tree model and a random forest model, to better capture the nonlinearity and high-order interactions that may be inherent in the relationship between the introduction of weekly options and crash risk. The results confirm that the introduction of weekly options is not important in explaining the crash risk of the underlying stocks. The author also examines the realized volatility of the underlying stocks and finds that it is not significantly affected by the introduction of weekly options. This study contributes to the literature on the impacts of derivatives on the underlying asset market and provides implications for empirical model specifications for crash risk studies.