The Response of Sector Index Options on Treasury Securities to Macro-economic Announcements

The flow of new information into a market changes prices as participants adjust their expectations in light of their new knowledge. This paper links two strands of existing micro-structure research by integrating recent findings on how macroeconomic announcements move markets with well-known theoretical relationships between asset prices and the value of their derivatives. This allows us to develop testable hypotheses about how sector index options on Treasury securities should behave before and after scheduled macroeconomic announcements. To our knowledge, this paper is the first attempt to use transactions data on index options to investigate the timing of pre-and post-announcement option price responses and volatility in the underlying cash market. Empirical results support our hypotheses in that we are able to identify a priori which announcements should lead to price movements in the options market; when, in which direction and for how long these price reactions should occur, and which announcements should generate the strongest option price response. We use transactions data to confirm each of our hypotheses and to demonstrate that the relationship between pre-announcement option prices and expected cash market volatility due to scheduled events is much more intricate and precise than has been documented in previous research.