Why Does Options Market Information Predict Stock Returns?

59 Pages Posted: 13 Oct 2016 Last revised: 26 May 2022

See all articles by Dmitriy Muravyev

Dmitriy Muravyev

Michigan State University - Department of Finance; Canadian Derivatives Institute

Neil D. Pearson

University of Illinois at Urbana-Champaign - Department of Finance

Joshua Matthew Pollet

University of Illinois at Urbana-Champaign - Department of Finance

Date Written: April 20, 2018

Abstract

Several influential studies show that options volatilities and trading volume predict stock returns. This predictability is puzzling because market participants can readily observe options market
data. We find that this predictability is consistent with option prices reflecting stock borrow fees
that are known to predict stock returns. We derive a formula relating the option-implied volatility
spread to the borrow fee. Motivated by this relation, we show that abnormal stock return predictability from option signals decreases by about two-thirds after returns are adjusted for
borrow fees. The predictability of unadjusted returns decreases by a similar amount if high-fee
stocks are excluded.

Keywords: equity options, put-call parity, implied volatility spread, implied volatility skew, stock borrowing fee, stock lending fee

JEL Classification: G12, G13, G14

Suggested Citation

Muravyev, Dmitriy and Pearson, Neil D. and Pollet, Joshua Matthew, Why Does Options Market Information Predict Stock Returns? (April 20, 2018). Available at SSRN: https://ssrn.com/abstract=2851560 or http://dx.doi.org/10.2139/ssrn.2851560

Dmitriy Muravyev (Contact Author)

Michigan State University - Department of Finance ( email )

315 Eppley Center
East Lansing, MI 48824-1122
United States

Canadian Derivatives Institute ( email )

3000, chemin de la Côte-Sainte-Catherine
Montréal, Québec H3T 2A7
Canada

Neil D. 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)

Joshua Matthew Pollet

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

1206 South Sixth Street
Champaign, IL 61820
United States
(217) 344-4311 (Phone)

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