Option Trading Volume Predicts Equity Returns
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Stock Return Predictability of Out-of-the-Money Option Trading
Chang Mo Kang; Geul Lee
- KRHanyang University
- ?Hanyang University - School of Business
- Missouri Southern State University
- KRChung-Ang University
- ?Coinplug, Inc
Strategy in a nutshell
The strategy focuses on U.S. stocks with available out-of-the-money (OTM) options data from the IvyDB OptionMetrics database and price data from CRSP. Each month, stocks are sorted into deciles based on their OTM put-to-call (OTMPC) ratio. The investor goes long on stocks in the bottom decile (lowest OTM put trading volume) and shorts stocks in the top decile (highest OTM put trading volume). The portfolio is value-weighted and rebalanced monthly.
Economic rationale
While prior research offers multiple interpretations, a common view is that informed traders use OTM options to act on private information, indirectly influencing stock prices. The authors propose that OTM options trading volumes predict major corporate events—such as mergers, acquisitions, or earnings surprises—which subsequently drive stock price movements anticipated by the options market.