The Joint Cross Section of Stocks and Options

Authors

  • BYEONG-JE AN,

  • ANDREW ANG,

  • TURAN G. BALI,

  • NUSRET CAKICI

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    • Byeong-Je An is at Columbia Business School, Columbia University, Andrew Ang is at Columbia Business School, Columbia University and NBER, Turan G. Bali is at McDonough School of Business, Georgetown University, and Nusret Cakici is at Fordham School of Business, Fordham University. We thank the Editor, Cam Harvey, an Associate Editor, and three referees for their extremely helpful comments and suggestions. We thank Reena Aggarwal, Allan Eberhart, Nicolae Garleanu, Larry Glosten, Bob Hodrick, Michael Johannes, George Panayotov, Tyler Shumway, Mete Soner, David Weinbaum, Rohan Williamson, Liuren Wu, Yuhang Xing, and seminar participants at the American Finance Association meetings, ETH-Zurich, Federal Reserve Bank of New York, and Georgetown University for helpful comments and discussions. Additional results are provided in an Internet Appendix available in the online version of this article on the Journal of Finance website.


ABSTRACT

Stocks with large increases in call (put) implied volatilities over the previous month tend to have high (low) future returns. Sorting stocks ranked into decile portfolios by past call implied volatilities produces spreads in average returns of approximately 1% per month, and the return differences persist up to six months. The cross section of stock returns also predicts option implied volatilities, with stocks with high past returns tending to have call and put option contracts that exhibit increases in implied volatility over the next month, but with decreasing realized volatility. These predictability patterns are consistent with rational models of informed trading.

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