Information Content of Call-Put Implied Volatility Spreads: Evidence from China's Option Markets

Abstract

This paper examines the information content of the call-put implied volatility spread (IVS) for Shanghai Stock Exchange (SSE) 50 ETF options from 2016 to 2023, defined as the difference in implied volatility between paired call and put options. We find that the IVS is negatively related to future SSE50 ETF returns at both weekly and monthly frequencies, which contrasts with prior research on the U.S. options markets, where the IVS is positively correlated with future market returns. The predictive power of the IVS for future market returns is significant both in-sample and out-of-sample in China. We explore several potential explanations for these findings, including investor sentiment, the option-implied borrowing fee, and liquidity demand as reflected in the IVS. The latter explanation best aligns with our analysis. Specially, we demonstrate that the IVS is closely linked to the option cash basis, predicts market returns with greater power around earnings announcements, and is contemporaneously positively associated with net flows into the ETF and market returns-reflecting liquidity demand that is common to option and equity market. Additionally, we observe pervasive liquidity demand across index-related options and futures markets.

Keywords: Put-call parity, Implied volatility spreads, Options-cash basis, SSE50 ETF options, Liquidity demand