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
Date Written: April 16, 2018
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: Suggested Citation