Stock Return Predictability: Consider Your Open Options
45 Pages Posted: 20 Jul 2017 Last revised: 2 Aug 2019
Date Written: July 31, 2019
Investors' views, expressed in individual securities, when averaged are informative about the future path of aggregate market returns. Our predictor of the market, PC-OI, is an average of traders' positions in options on individual stocks, formed simply by summing the put open interest across all stocks and dividing by the summed call open interest. Predictability is strongest when the measure is constructed from a subset of stocks subject to arbitrage constraints. The measure has strong in-sample and out-of-sample predictive power, and creates substantial utility gains for a mean-variance investor. The predictive power is not subsumed by the host of existing predictors in the literature. A trading strategy using our measure would have made up to 208% over our sample period, compared to a cumulative market return of 90%.
Keywords: Stock return predictability, options, open interest, limited attention, limits to arbitrage, idiosyncratic volatility.
JEL Classification: G11
Suggested Citation: Suggested Citation