Call-Put Implied Volatility Spreads and Option Returns
James S. Doran
Florida State University - Department of Finance
Florida State University - The College of Business
June 21, 2013
Review of Asset Pricing Studies, Forthcoming
Prior literature shows that the implied volatility spread between call and put options is a bullish signal for future returns on the underlying stocks. A common interpretation is that a high call-put implied volatility spread indicates favorable private information revealed by informed option investors. However, this paper finds that a high call-put implied volatility spread is a strong bearish signal for future returns on out-of-the-money call options. Using unique data on daily option volumes, we reconcile the two pieces of seemingly contradicting evidence by showing that demand for options by sophisticated, firm investors drives the positive relationship between volatility spreads and future stock returns, while demand for options by less sophisticated, customer investors drives the negative relationship between volatility spreads and future call option returns. Taken together, our evidence suggests that call-put implied volatility spreads contain information about firm fundamentals as well as option mispricing.
Number of Pages in PDF File: 49
Keywords: Implied Volatility Spread, Stock Returns, Option Returns, Option Demand
JEL Classification: G11, G12Accepted Paper Series
Date posted: July 15, 2010 ; Last revised: June 24, 2013
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