Options market makers’ delta hedging has an increasing impact on underlying stock prices as both the option volume and the ratio of option volume to stock volume grow drastically in recent years.
We introduce a novel approach utilizing real-time option information to calculate the spot elasticity of delta (ED) and expected hedging demand (EHD), and find that the EHD significantly predicts future stock returns in the cross section. The positive impact of EHD on stock prices lasts up to five trading days, and then a reversal follows. The empirical evidence of heterogeneous EHD-return relationship, influenced by ED, leads to varied option market maker behaviors, and is consistent with conventional economic theory. Moreover, we find that EHD has a little correlation with other popular firm characteristics, representing a new risk that is not captured by conventional factor models.