Why Do Option Prices Predict Stock Returns? The Role of Price Pressure in the Stock Market

Luis Goncalves-Pinto (), Bruce D. Grundy (), Allaudeen Hameed (), Thijs van der Heijden () and Yichao Zhu ()
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Luis Goncalves-Pinto: School of Banking and Finance, University of New South Wales, Sydney, New South Wales 2052, Australia; Department of Finance, Chinese University of Hong Kong, Hong Kong
Bruce D. Grundy: Department of Finance, University of Melbourne, Melbourne, Victoria 3010, Australia
Allaudeen Hameed: Department of Finance, National University of Singapore, Singapore 119245
Thijs van der Heijden: Department of Finance, University of Melbourne, Melbourne, Victoria 3010, Australia
Yichao Zhu: Research School of Finance, Actuarial Studies and Statistics, Australian National University, Canberra, Australian Capital Territory 0200, Australia

Management Science, 2020, vol. 66, issue 9, 3903-3926

Abstract: Stock and options markets can disagree about a stock’s value because of informed trading in options and/or price pressure in the stock. The predictability of stock returns based on this cross-market discrepancy in values is especially strong when accompanied by stock price pressure, and it does not depend on trading in options. We argue that option-implied prices provide an anchor for fundamental stock values that helps to distinguish stock price movements resulting from pressure versus news. Overall, our results are consistent with stock price pressure being the primary driver of the option price-based stock return predictability.

Keywords: price pressure; put–call parity; return predictability; informed trading (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (19)

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