High-frequency trading in the stock market and the costs of options market making

Abstract

We investigate how high-frequency trading (HFT) in equity markets affects options market liquidity. We find that increased aggressive HFT activity in the stock market leads to wider bid-ask spreads in the options market through two main channels. First, options market makers' quotes are exposed to sniping risk from HFTs exploiting put-call parity violations. Second, informed trading in the options market further amplifies the impact of HFT in equity markets on the liquidity of options by simultaneously increasing the options bid-ask spread and intensifying aggressive HFT activity in the underlying market.