Why Does Option Volume Predict Stock Returns? The Role of Investor Disagreement and Mispriced Stocks
62 Pages Posted: 28 Sep 2018 Last revised: 20 Jul 2020
Date Written: July 19, 2020
Divergence in investor beliefs is an important driver of the negative relation between option trading volume and future stock returns. We find a strong negative relation between disagreement-based option trades and future stock returns, and this relation is markedly amplified when the underlying stock is overpriced. This predictive effect of disagreement-based option volume on returns on mispriced stocks concentrates in highly levered options and when it is costly to short the stocks. Beyond the well-documented role of informed trading in options, our evidence suggests that intense trading in options also reflects elevated investor disagreement, particularly when stocks are mispriced.
Keywords: anomaly, mispricing, option trading volume, investor disagreement
JEL Classification: G10, G12, G14
Suggested Citation: Suggested Citation