Why does the option to stock volume ratio predict stock returns?

Li Ge, Tse-Chun Lin, Neil D. Pearson

Research output: Contribution to journal › Article › Research › peer-review

27 Citations (Scopus)

Abstract

Abstract We use data on signed option volume to study which components of option volume predict stock returns and resolve the seemingly inconsistent results in the literature. We find no evidence that trades related to synthetic short positions in the underlying stocks contain more information than trades related to synthetic long positions. Purchases of calls that open new positions are the strongest predictor of returns, followed by call sales that close out existing purchased call positions. Overall, our results indicate that the role of options in providing embedded leverage is the most important channel why option trading predicts stock returns.
Original languageEnglish
Pages (from-to)601 - 622
Number of pages22
JournalJournal of Financial Economics
Volume120
Issue number3
DOIs
Publication statusPublished - 2016

Keywords

  • Option trading volume
  • Stock return predictability
  • Information
  • Leverage

Cite this

Ge, Li ; Lin, Tse-Chun ; Pearson, Neil D. / Why does the option to stock volume ratio predict stock returns?. In: Journal of Financial Economics. 2016 ; Vol. 120, No. 3. pp. 601 - 622.
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title = "Why does the option to stock volume ratio predict stock returns?",
abstract = "Abstract We use data on signed option volume to study which components of option volume predict stock returns and resolve the seemingly inconsistent results in the literature. We find no evidence that trades related to synthetic short positions in the underlying stocks contain more information than trades related to synthetic long positions. Purchases of calls that open new positions are the strongest predictor of returns, followed by call sales that close out existing purchased call positions. Overall, our results indicate that the role of options in providing embedded leverage is the most important channel why option trading predicts stock returns.",
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Ge, L, Lin, T-C & Pearson, ND 2016, 'Why does the option to stock volume ratio predict stock returns?', Journal of Financial Economics, vol. 120, no. 3, pp. 601 - 622. https://doi.org/10.1016/j.jfineco.2015.08.019

Why does the option to stock volume ratio predict stock returns? / Ge, Li; Lin, Tse-Chun; Pearson, Neil D.

In: Journal of Financial Economics, Vol. 120, No. 3, 2016, p. 601 - 622.

Research output: Contribution to journal › Article › Research › peer-review

TY - JOUR

T1 - Why does the option to stock volume ratio predict stock returns?

AU - Ge, Li

AU - Lin, Tse-Chun

AU - Pearson, Neil D.

PY - 2016

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N2 - Abstract We use data on signed option volume to study which components of option volume predict stock returns and resolve the seemingly inconsistent results in the literature. We find no evidence that trades related to synthetic short positions in the underlying stocks contain more information than trades related to synthetic long positions. Purchases of calls that open new positions are the strongest predictor of returns, followed by call sales that close out existing purchased call positions. Overall, our results indicate that the role of options in providing embedded leverage is the most important channel why option trading predicts stock returns.

AB - Abstract We use data on signed option volume to study which components of option volume predict stock returns and resolve the seemingly inconsistent results in the literature. We find no evidence that trades related to synthetic short positions in the underlying stocks contain more information than trades related to synthetic long positions. Purchases of calls that open new positions are the strongest predictor of returns, followed by call sales that close out existing purchased call positions. Overall, our results indicate that the role of options in providing embedded leverage is the most important channel why option trading predicts stock returns.

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KW - Stock return predictability

KW - Information

KW - Leverage

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DO - 10.1016/j.jfineco.2015.08.019

M3 - Article

VL - 120

SP - 601

EP - 622

JO - Journal of Financial Economics

JF - Journal of Financial Economics

SN - 0304-405X

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Ge L, Lin T-C, Pearson ND. Why does the option to stock volume ratio predict stock returns? Journal of Financial Economics. 2016;120(3):601 - 622. https://doi.org/10.1016/j.jfineco.2015.08.019

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