Option‐implied information and quality of patents

• Published date: 01 January 2024
• Author: Wei‐Hsien Li,Jiahang Liang,Zih‐Ying Lin
• Date: 01 January 2024
• DOI: http://doi.org/10.1111/eufm.12412

DOI: 10.1111/eufm.12412

ORIGINAL ARTICLE

Option‐implied information and quality

of patents

Wei‐Hsien Li

1

|Jiahang Liang

2

|Zih‐Ying Lin

3

1

Department of Finance, National

Central University, Taoyuan City,

Taiwan

2

Master of Science in Finance, Carey

Business School, Johns Hopkins

University, Baltimore, Maryland, USA

3

Department of Finance and

International Business, Fu Jen Catholic

University, New Taipei City, Taiwan

Correspondence

Zih‐Ying Lin, Department of Finance

and International Business, Fu Jen

Catholic University, No. 510,

Zhongzheng Rd., Xinzhuang Dist., New

Taipei City 24205, Taiwan.

Email: 144638@mail.fju.edu.tw

Abstract

This research explores how option‐implied infor-

mation predicts quality of patents. Using several

measures of option‐implied information, we find

that only the option to stock volume (O/S) ratio

positively and significantly predicts quality of

patents around patent grant announcements. The

findings are not entirely driven by information from

the stock market and the probability of informed

trading. Further investigations show that the pre-

dictability of O/S on patent quality is stronger

when market sentiment is high, firms have a higher

short‐sale cost, and the quality of patents is

relatively high.

KEYWORDS

option to stock volume ratio (O/S), option‐implied information,

quality of patents

JEL CLASSIFICATION

G14, G12, O31

Eur Financ Manag. 2024;30:164–186.wileyonlinelibrary.com/journal/eufm164

|

© 2023 John Wiley & Sons Ltd.

EUROPEAN

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We thank John Doukas (the editor) and two anonymous referees for providing us with detailed and helpful comments

that greatly improved the paper. We also thank Pei‐Fang Hsieh, Carl Hsin‐Han Shen, Yan‐Zhi Wang and Weifeng

Hung for their valuable comments. We wish to thank the seminar participants at National Tsing Hua University and

the participants at the 2020 Annual International Conference of Taiwan Finance Association, the 8th Taiwan

Symposium on Innovation Economics and Entrepreneurship, and the 28th Conference on the Theories and Practices

and Financial Markets for comments. The authors are extremely grateful to Fundamental Research Funds from the

Humanity and Social Science Youth Foundation of Ministry of Education of China, 18YJC790097, the Ministry of

Science and Technology of Taiwan, and Hunan University for their financial support given to this study.

1|INTRODUCTION

Informed trading provides useful information from the price discovery process (Holden &

Subrahmanyam, 1992; Kyle, 1985). While some early studies focus on empirical tests of the

stock market (Kim et al., 1997; Womack, 1996), others point out that option‐implied

information measures are effective at predicting future stock return (Cremers & Weinbaum,

2010; Pan & Poteshman, 2006; Roll et al., 2010). Further research shows how options‐implied

information measures predict stock returns after corporate events like earnings announcements

(Atilgan, 2014), M&As (Augustin et al., 2019; Cao et al., 2005; Chan et al., 2015), spin‐offs

(Augustin et al., 2020), stock splits (Gharghori et al., 2017), share repurchases (Hao, 2016),

bankruptcy filing (Ge et al., 2019), and analyst recommendation changes (Hayunga & Lung,

2014). Thus, information from the options market should provide predictability in analyzing

other corporate events related to firm value.

Innovation plays a pivotal role in firm growth (Bloom & Van Reenen, 2002; Pástor &

Veronesi, 2009). Quality of innovation, often measured by a firm's patents and citations, is

documented as correlating to firm value and decisions (Bena & Li, 2014; Hall et al., 2005). Thus,

informed trading could also reveal information regarding innovation quality. In this paper, we

focus on information surrounding a patent grant announcement given that most of the

information content regarding the quality of a particular patent is revealed at that time.

1

Hsu

and Huh (2016) and Kogan et al. (2017) provide evidence supporting the existence of informed

trading in the stock market during a patent grant announcement, implying that informed

traders know about the quality of the patents. In the options market, Lin, Huang, et al. (2018)

find that options‐implied information can predict future patent grant announcement returns.

Despite not studying such announcements, Blanco and Wehrheim (2017) present a positive

relationship between options volumes and patents (citations). Bernile et al. (2021) show that

option listing relates to superior innovation. In this paper, we focus on how informed trading in

options markets predicts patent quality after a patent grant announcement.

We consider several option‐implied information measures such as the ratio of options to stock

volume (O/S), implied volatility (IV) spread, and the call‐put ratio (CP), which are known

effectively predict future stock returns (Cremers & Weinbaum, 2010; Pan & Poteshman, 2006;Roll

et al., 2010). Each measure captures different combinations of information, including prices, signed

or unsigned trading volume, or trading volume from the options and/or stock market. It is an

empirical question as to which measure captures the abovementioned predictability.

Using 181,215 patent grant announcements from 1996 to 2018 and citation information up

to 2019, we regress patent quality proxies on option‐implied information measures along with

control variables. We use the number of citations as our proxy for patent quality.

2

We show that

only O/S positively and significantly predicts patent citations. These results are consistent with

prior studies' findings that O/S contains market information (Chan et al., 2015; Roll et al., 2010)

and are robust against different fixed effects specifications, sample construction concerns, and

alternative explanations. Specifically, our findings are neither driven by the data coverage

1

A patent grant announcement is defined as the date when a firm is granted the patent and not the application date (see, Kogan et al.,

2017). In the United States, the patent grant announcement date is typically on Tuesday. On the patent grant announcement date, the

market knew about the existence of the patent application but not the quality of the applied patent. This makes the patent grant

announcement an event more focus on the quality of patent than other patent‐related announcements. However, some would argue that

the market may learn the technical details of the patent before it is granted. The results from Kogan et al. (2017) confirm that the

information content during the application date is small.

2

Hall et al. (2005) show that forward citations correlate to firm value.

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