Fundamental Analysis and Option Returns

Abstract

This paper investigates whether fundamental accounting information is appropriately priced in the options market. We find that fundamental accounting signals exhibit incremental predictive power with respect to future option returns above and beyond what is captured by implied and historical stock volatility, suggesting that the options market does not fully incorporate fundamental information into option prices. Transaction costs substantially reduce the overall profitability of hedge strategies that exploit the information in these fundamental accounting signals, but the strategies still earn economically and statistically significant returns for options with low transaction costs.

Keywords: Fundamental analysis, return, volatility, accounting signals

JEL Classification: G11, G12, G13, G14, M41