57 PagesPosted: 13 Oct 2016Last revised: 15 Jun 2023
See all articles by Dmitriy Muravyev
Dmitriy Muravyev
University of Illinois at Urbana-Champaign - Department of Finance; Canadian Derivatives Institute
Neil D. Pearson
University of Illinois at Urbana-Champaign - Department of Finance
Joshua Matthew Pollet
University of Illinois at Urbana-Champaign - Department of Finance
Date Written: April 20, 2018
Abstract
Several influential studies show that transformations of implied volatilities calculated from options prices predict stock returns. This predictability is puzzling because market participants can readily observe options prices. We find that this predictability is consistent with implied volatilities reflecting stock borrow fees that are known to predict stock returns. We derive a formula relating the option-implied volatility spread to the borrow fee. Motivated by this relation, we show that the return predictability from the option signals decreases by about two-thirds if high-fee stocks are excluded. The predictability decreases by a similar amount after stock returns are adjusted for borrow fees.
Keywords: equity options, put-call parity, implied volatility spread, implied volatility skew, stock borrowing fee, stock lending fee
JEL Classification: G12, G13, G14
Suggested Citation:Suggested Citation
Muravyev, Dmitriy and Pearson, Neil D. and Pollet, Joshua Matthew, Why Does Options Market Information Predict Stock Returns? (April 20, 2018). Available at SSRN: https://ssrn.com/abstract=2851560 or http://dx.doi.org/10.2139/ssrn.2851560
Dmitriy Muravyev (Contact Author)
University of Illinois at Urbana-Champaign - Department of Finance ( email )
1206 South Sixth Street
Champaign, IL 61820
United States
217-7213772 (Phone)
Canadian Derivatives Institute ( email )
3000, chemin de la Côte-Sainte-Catherine
Montréal, Québec H3T 2A7
Canada
Neil D. Pearson
University of Illinois at Urbana-Champaign - Department of Finance ( email )
1206 South Sixth Street
Champaign, IL 61820
United States
217-244-0490 (Phone)
217-244-9867 (Fax)
Joshua Matthew Pollet
University of Illinois at Urbana-Champaign - Department of Finance ( email )
1206 South Sixth Street
Champaign, IL 61820
United States
(217) 344-4311 (Phone)