Dynamic Incentives in REIT Option Markets

Abstract

The academic literature generally views option traders as a homogenous set of informed investors. However, while prior empirical studies have consistently identified a relationship between option trading volume and subsequent asset returns, they have largely been unable to directly assess the profitability of these trades. This paper leverages a novel dataset that enables inference of option trade directionality to examine whether, and to what extent, REIT option traders are able to anticipate directional movements in the prices of the underlying securities. Consistent with methods used in prior finance literature, we employ a proxy for option trading behavior based on transactions initiated by option market makers. This proxy is particularly well suited for the REIT space, where the option market is relatively thin and market makers play a disproportionately large role in trading activity. We first document intraday patterns in REIT option trading and then find that informed trading activity is most prevalent in the middle of the trading day, whereas hedging-driven trades tend to dominate towards the market closing. These findings challenge the conventional view that options markets function primarily as venues for informed speculation, instead emphasizing their dual purpose as instruments for both speculative positioning and risk management. Overall, this study provides compelling evidence that the motivations behind REIT option trades are heterogeneous and evolve predictably over the trading day.