Review of Asset Pricing Studies, 2013(3): 258-290
49 Pages Posted: 15 Jul 2010 Last revised: 14 Jan 2014
Date Written: June 21, 2013
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.
Keywords: Implied Volatility Spread, Stock Returns, Option Returns, Option Demand
JEL Classification: G11, G12
Suggested Citation: Suggested Citation
Doran, James and Fodor, Andy and Jiang, Danling, Call-Put Implied Volatility Spreads and Option Returns (June 21, 2013). Review of Asset Pricing Studies, 2013(3): 258-290. Available at SSRN: https://ssrn.com/abstract=1640322 or http://dx.doi.org/10.2139/ssrn.1640322