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THE LEAD-LAG RELATIONSHIP BETWEEN THE OPTION AND STOCK MARKETS PRIOR TO SUBSTANTIAL EARNINGS SURPRISES AND THE EFFECT OF SECURITIES REGULATION

This study investigates the lead-lag relationship between the option and stock markets for 17 trading-days prior to substantial earnings surprises, using the Berkeley options data base, changes in put-call parity, and a control option methodology. Before the passage of the Insider Trading Sanctions Act (ITSA) in 1984, the options market leads the stock market prior to negative surprises but that the stock market leads prior to positive surprises. After the passage of ITSA there is no leading role for either market under positive or negative surprises. These results may suggest important roles for institutional factors, such as short sale constraints, and the intensity of securities regulation.