Volatility Aversion in the Options Market Based on News Sentiment

Abstract

The perennial question of efficient markets is whether investors respond rationally to new information. If they “overreact” or “underreact” to a news release, is it a simple error or systematic bias? A major problem in testing this is the need to be clear on what “news” is and when investors learn it. This is especially hard because evaluating new information is inherently subjective and may have its largest impact on what is typically called investor sentiment. In this article, the author focuses on news about the macroeconomy, using textual analysis on news items carried by Thomson Reuters to explore the impact of positive and negative news on implied volatilities (IVs) from SPX options. What should move the market is a change in sentiment, which the author measures by the change in the incidence of positive and negative words in relevant news items. Coefficient estimates across moneyness and maturity are uniformly negative for positive sentiment (good news makes IVs go down) and positive for negative sentiment. Differences show up between puts and calls and across moneyness. Interestingly, the impact is significant in most cases for positive but not negative news. Short maturity out-of-the-money put IVs are particularly sensitive to positive macro information, while negative news affects both calls and puts at the money.