The Joint Cross Section of Stocks and Options

Abstract:     
Option volatilities have significant predictive power for the cross section of stock returns and vice versa. Stocks with large increases in call implied volatilities tend to rise over the following month and increases in put implied volatilities forecast future decreases in next-month stock returns. The spread in average returns and alphas between the first and fifth quintile portfolios formed by ranking on lagged changes in implied call volatilities is approximately 1% per month. Going in the other direction, stocks with high returns over the past month tend to have call option contracts that exhibit increases in implied volatility over the next month, but realized volatility for those stocks tends to decrease.

Number of Pages in PDF File: 59

Keywords: implied volatility, risk premiums, predictability, short-term momentum

JEL Classification: G10, G11, C13

working papers series