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Why Does the Option to Stock Volume Ratio Predict Stock Returns?

59 Pages Posted: 22 Jul 2014 Last revised: 17 Aug 2015

Li Ge

Monash University - Monash Business School

Tse-Chun Lin

The University of Hong Kong - Faculty of Business and Economics

Neil D. Pearson

University of Illinois at Urbana-Champaign - Department of Finance

Date Written: August 9, 2015

Abstract

We use data on signed option volume to study which components of option volume predict stock returns and resolve the seemingly inconsistent results in the literature. We find no evidence that trades related to synthetic short positions in the underlying stocks contain more information than trades related to synthetic long positions. Purchases of calls that open new positions are the strongest predictor of returns, followed by call sales that close out existing purchased call positions. Overall our results indicate that the role of options in providing embedded leverage is the most important channel why option trading predicts stock returns.

Keywords: Option trading volume, stock return predictability, information, leverage

JEL Classification: G12, G13, G14

Suggested Citation

Ge, Li and Lin, Tse-Chun and Pearson, Neil D., Why Does the Option to Stock Volume Ratio Predict Stock Returns? (August 9, 2015). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2329714 or http://dx.doi.org/10.2139/ssrn.2329714

Li Ge

Monash University - Monash Business School ( email )

Building H Level 3, 900 Dandenong Road
Caulfield East
Melbourne, Victoria 3145
Australia
+61 399032123 (Phone)

Tse-Chun Lin (Contact Author)

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Neil Pearson

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
217-244-0490 (Phone)
217-244-9867 (Fax)

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