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

54 Pages Posted: 24 Nov 2015 Last revised: 24 Apr 2018

Luis Goncalves-Pinto

Chinese University of Hong Kong - Department of Finance

Bruce D. Grundy

University of Melbourne

Allaudeen Hameed

National University of Singapore (NUS) - Department of Finance

Thijs van der Heijden

The 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: April 16, 2018

Abstract

We study stock return predictability derived from option prices. Stock and options markets can disagree about a stock's value because of informed trading in options on the stock and/or temporary price pressure in the stock itself. We find that this cross-market discrepancy in values is strongly related to return reversals, order imbalances, and illiquidity in stocks, and does not depend on trading in options. We conclude that stock price pressure is the primary driver of the option price-based stock return predictability, both unconditionally and around earnings announcements.

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 (April 16, 2018). 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

Chinese University of Hong Kong - Department of Finance ( email )

Cheng Yu Tung Building
Shatin
Hong Kong
Hong Kong

Bruce D. Grundy

University of Melbourne ( email )

Faculty of Economics & Commerce
Department of Finance
Victoria, 3010
Australia
+61 3 8344 9083 (Phone)
+61 3 8344 6914 (Fax)

Allaudeen Hameed

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

Mochtar Riady Building
15 Kent Ridge Drive
Singapore, 119245
Singapore

HOME PAGE: http://www.bschool.nus.edu.sg/staff_profile/cv.asp?ID=3

Thijs Van der Heijden (Contact Author)

The 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 st.
acton, ACT 0200
Australia

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