Working Paper: NBER ID: w10925
Authors: Jun Pan; Allen Poteshman
Abstract: We present strong evidence that option trading volume contains information about future stock price movements. Taking advantage of a unique dataset from the Chicago Board Options Exchange, we construct put-call ratios from option volume initiated by buyers to open new positions. On a risk-adjusted basis, stocks with low put-call ratios outperform stocks with high put-call ratios by more than 40 basis points on the next day and more than 1% over the next week. Partitioning our option signals into components that are publicly and non-publicly observable, we find that the economic source of this predictability is non-public information possessed by option traders rather than market inefficiency. We also find greater predictability from option signals for stocks with higher concentrations of informed traders and from option contracts with greater leverage.
Keywords: option trading volume; stock price predictability; put-call ratios; informed trading
JEL Codes: G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Option trading volume (G13) | Future stock price movements (G17) |
| Low put-call ratios (G19) | Higher subsequent stock returns (G17) |
| Presence of informed traders (G14) | Greater predictability from option signals (G13) |
| Private information possessed by option traders (G13) | Economic source of predictability (D84) |