Do Option Prices Forecast Aggregate Stock Returns?

71 Pages Posted: 27 Jul 2017 Last revised: 22 Aug 2018

See all articles by Christopher S. Jones

Christopher S. Jones

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Haitao Mo

Louisiana State University, Baton Rouge - E.J. Ourso College of Business Administration

Tong Wang

UNIV OF OKLAHOMA

Date Written: July 31, 2018

Abstract

We show that the average difference between the implied volatilities of call and put options on individual equities, which we term the implied volatility spread (IVS), has strong predictive power for stock market returns at horizons between one and six months, with monthly in-sample and out-of-sample R-squares around 5%. Controlling for other common predictive variables increases the significance of IVS and lengthens the horizons at which it is significant. We further show that IVS forecasts future surprises in aggregate earnings and growth rates in GDP and aggregate dividends. We conclude that this predictability is likely driven by expectations of stock lending fees embedded in IVS and is inconsistent with explanations based on informed option trading, time-varying risk premia, or illiquidity.

Keywords: Return Predictability, Options, Implied Volatility

JEL Classification: G12, C11

Suggested Citation

Jones, Christopher S. and Mo, Haitao and Wang, Tong, Do Option Prices Forecast Aggregate Stock Returns? (July 31, 2018). Available at SSRN: https://ssrn.com/abstract=3009490 or http://dx.doi.org/10.2139/ssrn.3009490

Christopher S. Jones

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

Haitao Mo

Louisiana State University, Baton Rouge - E.J. Ourso College of Business Administration ( email )

Baton Rouge, LA 70803-6308
United States

Tong Wang (Contact Author)

UNIV OF OKLAHOMA ( email )

307 West Brooks, Room 205A
Norman, OK 73019
United States
2132357250 (Phone)

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