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

See all articles by Allaudeen Hameed

Allaudeen Hameed

National University of Singapore (NUS) - Department of Finance

Byounghyun Jeon

Marquette University

Date Written: July 19, 2020

Abstract

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

Hameed, Allaudeen and Jeon, Byounghyun, Why Does Option Volume Predict Stock Returns? The Role of Investor Disagreement and Mispriced Stocks (July 19, 2020). Available at SSRN: https://ssrn.com/abstract=3256061 or http://dx.doi.org/10.2139/ssrn.3256061

Allaudeen Hameed (Contact Author)

National University of Singapore (NUS) - Department of Finance ( email )

Mochtar Riady Building
15 Kent Ridge Drive
Singapore, 119245
Singapore

HOME PAGE: http://bizfaculty.nus.edu.sg/faculty-details/?profId=1

Byounghyun Jeon

Marquette University ( email )

College of Business Administration
P.O. Box 1881
Milwaukee, WI 53201-1881
United States
414-690-2025 (Phone)

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