51 Pages Posted: 5 Mar 2007 Last revised: 18 Jul 2008
Deviations from put-call parity contain information about future returns. Using the difference in implied volatility between pairs of call and put options to measure these deviations we find that stocks with relatively expensive calls outperform stocks with relatively expensive puts by 51 basis points per week. We find both positive abnormal performance in stocks with relatively expensive calls and negative abnormal performance in stocks with relatively expensive puts, a result which cannot be explained by short sales constraints. Using rebate rates from the stock lending market, we confirm directly that our findings are not driven by stocks that are hard to borrow. Options with more leverage generate greater predictability. Controlling for size, deviations from put-call parity are more likely to occur in options with underlying stocks that face more information risk. Deviations from put-call parity also tend to predict returns to a larger extent in firms that face a more asymmetric information environment, and in firms with high residual analyst coverage. We also find that the degree of predictability decreases over the sample period. Our results are consistent with mispricing during the earlier years of the study, with a gradual reduction of the mispricing over time.
Keywords: options, predictability, put-call parity
JEL Classification: G13, G14
Suggested Citation: Suggested Citation
Cremers, Martijn and Weinbaum, David, Deviations from Put-Call Parity and Stock Return Predictability. Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: https://ssrn.com/abstract=968237
By Meb Faber