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Why Do Option Prices Predict Stock Returns? The Role of Price Pressure in the Stock Market

Forthcoming in Management Science

FIRN Research Paper No. 2695145

61 Pages Posted: 24 Nov 2015 Last revised: 5 Jun 2019

See all articles by Luis Goncalves-Pinto

Luis Goncalves-Pinto

University of New South Wales (UNSW)

Bruce D. Grundy

RSFAS Australian National University

Allaudeen Hameed

National University of Singapore (NUS) - Department of Finance

Thijs van der Heijden

University of Melbourne - Department of Finance; Financial Research Network (FIRN)

Yichao Zhu

Australian National University (ANU) - Research School of Finance, Actuarial Studies and Applied Statistics

Date Written: May 10, 2019

Abstract

Stock and options markets can disagree about a stock's value because of informed trading in options and/or price pressure in the stock. The predictability of stock returns based on this cross- market discrepancy in values is especially strong when accompanied by stock price pressure, and it does not depend on trading in options. We argue that option-implied prices provide an anchor for fundamental stock values that helps to distinguish stock price movements due to pressure versus news. Overall, our results are consistent with stock price pressure being the primary driver of the option price-based stock return predictability.

Keywords: Price Pressure, Put-Call Parity, Return Predictability, Informed Trading

JEL Classification: G11, G12, C13

Suggested Citation

Goncalves-Pinto, Luis and Grundy, Bruce D. and Hameed, Allaudeen and van der Heijden, Thijs and Zhu, Yichao, Why Do Option Prices Predict Stock Returns? The Role of Price Pressure in the Stock Market (May 10, 2019). Forthcoming in Management Science, FIRN Research Paper No. 2695145, Available at SSRN: https://ssrn.com/abstract=2695145 or http://dx.doi.org/10.2139/ssrn.2695145

Luis Goncalves-Pinto

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

HOME PAGE: http://luis.goncalvespinto.com/

Bruce D. Grundy

RSFAS Australian National University ( email )

Kingsley Street
Acton ACT
Australia
0431247108 (Phone)

Allaudeen Hameed

National University of Singapore (NUS) - Department of Finance ( email )

Mochtar Riady Building
15 Kent Ridge Drive
Singapore, 119245
Singapore

HOME PAGE: http://bizfaculty.nus.edu.sg/faculty-details/?profId=1

Thijs Van der Heijden (Contact Author)

University of Melbourne - Department of Finance ( email )

198 Berkeley Street
Carlton VIC 3010
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Yichao Zhu

Australian National University (ANU) - Research School of Finance, Actuarial Studies and Applied Statistics ( email )

Kingsley Street
acton, ACT 0200
Australia

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