Call-Put Implied Volatility Spreads and Option Returns

Review of Asset Pricing Studies, 2013(3): 258-290

49 Pages Posted: 15 Jul 2010 Last revised: 14 Jan 2014

See all articles by James Doran

James Doran

University of New South Wales

Andy Fodor

Ohio University

Danling Jiang

College of Business, Stony Brook University

Date Written: June 21, 2013

Abstract

Prior literature shows that the implied volatility spread between call and put options is a bullish signal for future returns on the underlying stocks. A common interpretation is that a high call-put implied volatility spread indicates favorable private information revealed by informed option investors. However, this paper finds that a high call-put implied volatility spread is a strong bearish signal for future returns on out-of-the-money call options. Using unique data on daily option volumes, we reconcile the two pieces of seemingly contradicting evidence by showing that demand for options by sophisticated, firm investors drives the positive relationship between volatility spreads and future stock returns, while demand for options by less sophisticated, customer investors drives the negative relationship between volatility spreads and future call option returns. Taken together, our evidence suggests that call-put implied volatility spreads contain information about firm fundamentals as well as option mispricing.

Keywords: Implied Volatility Spread, Stock Returns, Option Returns, Option Demand

JEL Classification: G11, G12

Suggested Citation

Doran, James and Fodor, Andy and Jiang, Danling, Call-Put Implied Volatility Spreads and Option Returns (June 21, 2013). Review of Asset Pricing Studies, 2013(3): 258-290, Available at SSRN: https://ssrn.com/abstract=1640322 or http://dx.doi.org/10.2139/ssrn.1640322

James Doran

University of New South Wales ( email )

College Rd
Sydney, NSW 2052
Australia

Andy Fodor

Ohio University ( email )

514 Copeland Hall
Athens, OH 45701
United States
740.593.0259 (Phone)

Danling Jiang (Contact Author)

College of Business, Stony Brook University ( email )

306 Harriman Hall
Stony Brook, NY 11794
United States

HOME PAGE: http://sites.google.com/site/danlingjiang

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