Volatility Spreads and Earnings Announcement Returns

30 Pages Posted: 25 Nov 2009 Last revised: 28 Jul 2015

Yigit Atilgan

Sabanci University

Date Written: December 12, 2012

Abstract

Prior research documents that volatility spreads predict stock returns. If the trading activity of informed investors is an important driver of volatility spreads, then the predictability of stock returns should be more pronounced during major information events. This paper investigates whether the predictability of equity returns by volatility spreads is stronger during earnings announcements. Volatility spreads are measured by the implied volatility differences between pairs of strike price and expiration date matched put and call options and capture price pressures in the option market. During a two-day earnings announcement window, the abnormal returns to the quintile that includes stocks with relatively expensive call options is more than 1.5 percent greater than the abnormal returns to the quintile that includes stocks with relatively expensive put options. This result is robust after measuring volatility spreads in alternative ways and controlling for ¬Öfirm characteristics and lagged equity returns. The degree of announcement return predictability is stronger when volatility spreads are measured using more liquid options, the information environment is more asymmetric, and stock liquidity is low.

Keywords: cross-section of equity returns, volatility spreads, equity options, information flow, put-call parity.

JEL Classification: G10, G12, G13, G14

Suggested Citation

Atilgan, Yigit, Volatility Spreads and Earnings Announcement Returns (December 12, 2012). Journal of Banking and Finance, Vol. 38, No. 1, 2014. Available at SSRN: https://ssrn.com/abstract=1512046 or http://dx.doi.org/10.2139/ssrn.1512046

Yigit Atilgan (Contact Author)

Sabanci University ( email )

Orta Mahalle √úniversite Caddesi 27
Istanbul, Orhanli, 34956 Tuzla 34956
Turkey

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