Abstract

http://ssrn.com/abstract=2400955
 
 

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Why Do Options Prices Predict Stock Returns?


Tse-Chun Lin


University of Hong Kong - Faculty of Business and Economics

Xiaolong Lu


University of Hong Kong - Faculty of Business and Economics

Joost Driessen


Tilburg University - Department of Finance; CentER Tilburg University

July 1, 2013

Netspar Discussion Paper No. 07/2013-079

Abstract:     
We use a new approach to assess the information transmission between options and stock markets. We study whether the predictive power of option-implied volatilities (IVs) on stock returns lies in analyst-related and/or earnings-related news. We find that two proxies for options trading (IV skew and IV spread) predict analyst recommendation changes, analyst forecast revisions, and earnings surprises. Next, we show that the IV skew and IV spread predict stock returns, and that the degree of predictability more than doubles around analyst-related and earnings-related events. Additionally, we find that informed traders choose to use the options market particularly because of short-sale constraints on the underlying stock. We also find that the informed options trading increases with the options market liquidity.

Number of Pages in PDF File: 49

Keywords: Informed traders, corporate events, implied volatility spread, implied volatility skew, short-sale constraint

JEL Classification: G12, G14, G17

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Date posted: February 25, 2014  

Suggested Citation

Lin, Tse-Chun and Lu, Xiaolong and Driessen, Joost, Why Do Options Prices Predict Stock Returns? (July 1, 2013). Netspar Discussion Paper No. 07/2013-079. Available at SSRN: http://ssrn.com/abstract=2400955 or http://dx.doi.org/10.2139/ssrn.2400955

Contact Information

Tse-Chun Lin
University of Hong Kong - Faculty of Business and Economics ( email )
Pok Fu Lam Road
Hong Kong
Hong Kong
+852 2857-8503 (Phone)
HOME PAGE: http://www.sef.hku.hk/people/faculty/tclin.html
Xiaolong Lu
University of Hong Kong - Faculty of Business and Economics ( email )
Rm1122, KK Leung Building
Pokfulam Road
Hong Kong
China
Joost Driessen (Contact Author)
Tilburg University - Department of Finance ( email )
P.O. Box 90153
Tilburg, 5000 LE
Netherlands
CentER Tilburg University ( email )
P.O. Box 90153
Tilburg, 5000 LE
Netherlands
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