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Price Discovery in Stock and Options Markets

Using a new empirical technique — the information leadership share — we find that the role of options in price discovery is up to six times larger than previously thought. At least one-third of new information is reflected in option prices before being transmitted to stock prices. Using unique data on prosecuted insider trading we validate our estimates and find that one-third of the time informed traders choose to trade in options. Doing so substantially increases their percentage profits. Consequently, options play a key role in price discovery around important information events. Our results reconcile conflicting findings in the existing literature.