Internet Appendix to the Only Constant is Change: Non-Constant Volatility and Implied Volatility Spreads

Abstract

We examine the predictability of stock returns using implied volatility spreads (VS) from individual (non-index) options. Volatility spreads can occur under simple no-arbitrage conditions for American options when volatility is time-varying, suggesting that the VS-return predictability could be an artifact of firms’ sensitivities to aggregate volatility. Examining this empirically, we find that the predictability changes systematically with aggregate volatility and is positively related to the firms’ sensitivities to volatility risk. The alpha generated by VS hedge portfolios can be explained by aggregate volatility risk factors. Our results cannot be explained by firm-specific informed trading, transaction costs, or liquidity.

Keywords: Implied Volatility Spreads, Non-constant Volatility

JEL Classification: G11, G12