Option Informed Stock Picking
Posted: 6 Jun 2019
Date Written: November 12, 2016
A wide range of research has suggested that informed trading in options markets may effectively signal subsequent changes in equity prices. In this paper, we analyze the performance of long/short strategies based on a number of signals from options markets.
In addition, we create an easily implemented long-only strategy based on a subset of the signals (volatility risk premium, option/stock volume ratio, implied volatility skew and realized volatility). In order to minimize transaction costs and liquidity issues we restrict our analysis to S&P 500 constituents, we rebalance our portfolio monthly and limit our holdings to 50 individual stocks.
Our analysis of the period from 1996 through mid-2015 shows significant outperformance of a long-only equal weighted portfolio of 50 stocks (similar results were found when considering 10-stock portfolios), relative to the S&P 500 and the equal weighted S&P 500. A return attribution analysis confirms that the outperformance is provided by individual stock selection rather than sector selection.
Keywords: Implied Volatility, Stock Picking, Skew, Option Volume
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation