Informed Trading of Options, Option Expiration Risk, and Stock Return Predictability
52 Pages Posted: 22 Mar 2019
Date Written: March 5, 2019
The percentage difference between implied stock prices from options and actual stock prices, which we term the implied price difference (‘IPD’), predicts stock returns up to ten months into the future. IPD predicts stock returns even after including a number of other option-based variables, and among both the largest stocks as well as small cap stocks. Information about future stock returns comes from long-term, not short-term options. This suggests that informed investors who do not know when their longer-term information will be impounded in prices tend to trade long-term options to avoid expiration risk.
Keywords: options implied stock prices, expiration risk, stock return predictability
JEL Classification: G14
Suggested Citation: Suggested Citation