Hostname: page-component-745bb68f8f-5r2nc Total loading time: 0 Render date: 2025-01-10T12:34:02.507Z Has data issue: false hasContentIssue false
  • English
  • Français

Deviations from Put-Call Parity and Stock Return Predictability

Published online by Cambridge University Press:  19 February 2010

Martijn Cremers  and
David Weinbaum
Martijn Cremers
Affiliation:
School of Management, Yale University, Box 20820, New Haven, CT 06520. martijn.cremers@yale.edu
David Weinbaum
Affiliation:
Whitman School of Management, Syracuse University, 721 University Ave., Syracuse, NY 13244. dweinbau@syr.edu
Get access Rights & Permissions [Opens in a new window]

Abstract

Deviations from put-call parity contain information about future stock returns. Using the difference in implied volatility between pairs of call and put options to measure these deviations, we find that stocks with relatively expensive calls outperform stocks with relatively expensive puts by 50 basis points per week. We find both positive abnormal performance in stocks with relatively expensive calls and negative abnormal performance in stocks with relatively expensive puts, which cannot be explained by short sale constraints. Rebate rates from the stock lending market directly confirm that our findings are not driven by stocks that are hard to borrow. The degree of predictability is larger when option liquidity is high and stock liquidity low, while there is little predictability when the opposite is true. Controlling for size, option prices are more likely to deviate from strict put-call parity when underlying stocks face more information risk. The degree of predictability decreases over the sample period. Our results are consistent with mispricing during the earlier years of the study, with a gradual reduction of the mispricing over time.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 2 , April 2010 , pp. 335 - 367
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Acharya, V., and Pedersen, L.. “Asset Pricing with Liquidity Risk.” Journal of Financial Economics, 77 (2005), 375–410.CrossRefGoogle Scholar
Amihud, Y. “Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 31–56.CrossRefGoogle Scholar
Amihud, Y.; Mendelson, H.; and Lauterbach, B.. “Market Microstructure and Security Values: Evidence from the Tel-Aviv Exchange.” Journal of Financial Economics, 45 (1997), 365–390.CrossRefGoogle Scholar
Amin, K.; Coval, J.; and Seyhun, H. N.. “Index Option Prices And Stock Market Momentum.” Journal of Business, 77 (2004), 835–873.CrossRefGoogle Scholar
Anand, A., and Chakravarty, S.. “Stealth Trading in Options Markets.” Journal of Financial and Quantitative Analysis, 42 (2007), 167–187.CrossRefGoogle Scholar
Andrews, D. “Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation.” Econometrica 59 (1991), 817–858.CrossRefGoogle Scholar
Aslan, H.; Easley, D.; Hvidkjaer, S.; and O’Hara, M.. “Firm Characteristics and Informed Trading: Implications for Asset Pricing.” Working Paper, Cornell University (2007).CrossRefGoogle Scholar
Back, K. “Asymmetric Information and Options.” Review of Financial Studies, 6 (1993), 435–472.CrossRefGoogle Scholar
Barberis, N., and Huang, M.. “Stocks as Lotteries: The Implications of Probability Weighting for Security Prices.” American Economic Review, 98 (2008), 2066–2100.CrossRefGoogle Scholar
Battalio, R., and Schultz, P.. “Options and the Bubble.” Journal of Finance, 61 (2006), 2071–2102.CrossRefGoogle Scholar
Bhattacharya, M. “Price Changes of Related Securities: The Case of Call Options and Stocks.” Journal of Financial and Quantitative Analysis, 22 (1987), 1–15.CrossRefGoogle Scholar
Biais, B., and Hillion, P.. “Insider and Liquidity Trading in Stock and Option Markets.” Review of Financial Studies, 74 (1994), 743–780.CrossRefGoogle Scholar
Black, F. “Fact and Fantasy in the Use of Options.” Financial Analysts Journal, 31 (1975), 36–72.CrossRefGoogle Scholar
Black, F., and Scholes, M.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 81 (1973), 637–654.CrossRefGoogle Scholar
Bollen, N., and Whaley, R.. “Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?” Journal of Finance, 59 (2004), 711–753.CrossRefGoogle Scholar
Brennan, M., and Cao, H.. “Information, Trade, and Derivative Securities.” Review of Financial Studies, 9 (1996), 163–208.CrossRefGoogle Scholar
Brenner, M., and Galai, D.. “Implied Interest Rates.” Journal of Business, 59 (1986), 493–507.CrossRefGoogle Scholar
Broadie, M.; Chernov, M.; and Johannes, M.. “Model Specification and Risk Premia: Evidence from Futures Options.” Journal of Finance, 62 (2007), 1453–1490.CrossRefGoogle Scholar
Broadie, M.; Chernov, M.; and Johannes, M.. “Understanding Index Option Returns.” Review of Financial Studies, 22 (2009), 4493–4529.CrossRefGoogle Scholar
Brown, S.; Hillegeist, S.; and Lo, K.. “Conference Calls and Information Asymmetry.” Journal of Accounting and Economics, 37 (2004), 343–366.CrossRefGoogle Scholar
Cao, C.; Chen, Z.; and Griffin, J.. “The Informational Content of Option Volume Prior to Takeovers.” Journal of Business, 78 (2005), 1073–1109.CrossRefGoogle Scholar
Cao, H. “The Effect of Derivative Assets on Information Acquisition and Price Behavior in a Rational Expectations Equilibrium.” Review of Financial Studies, 12 (1999), 131–163.CrossRefGoogle Scholar
Carhart, M. “On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 57–82.CrossRefGoogle Scholar
Chakravarty, S.; Gulen, H.; and Mayhew, S.. “Informed Trading in Stock and Option Markets.” Journal of Finance, 59 (2004), 1235–1257.CrossRefGoogle Scholar
Chan, K.; Chung, Y. P.; and Fong, W.-M.. “The Informational Role of Stock and Option Volume.” Review of Financial Studies, 15 (2002), 1049–1075.CrossRefGoogle Scholar
Chan, K.; Chung, Y. P.; and Johnson, H.. “Why Option Prices Lag Stock Prices: A Trading-Based Explanation.” Journal of Finance, 48 (1993), 1957–1967.Google Scholar
Cochrane, J. “Asset Pricing: Liquidity, Trading, and Asset Prices.” NBER Reporter, Winter 2004/5 (2005), 1–12.Google Scholar
Cohen, L.; Diether, K.; and Malloy, C.. “Supply and Demand Shifts in the Shorting Market.” Journal of Finance, 62 (2007), 2061–2096.CrossRefGoogle Scholar
Conrad, J.; Dittmar, R.; and Ghysels, E.. “Skewness and the Bubble.” Working Paper, University of North Carolina at Chapel Hill (2008).CrossRefGoogle Scholar
D’Avolio, G. “The Market for Borrowing Stock.” Journal of Financial Economics, 66 (2002), 271–306.CrossRefGoogle Scholar
Duarte, J.; Lou, X.; and Sadka, R.. “Option-Based Hedging of Liquidity Costs in Short Selling.” Working Paper, University of Washington (2005).Google Scholar
Easley, D.; Hvidkjaer, S.; and O’Hara, M.. “Is Information Risk a Determinant of Asset Returns?” Journal of Finance, 57 (2002), 2185–2221.CrossRefGoogle Scholar
Easley, D.; Kiefer, N.; and O’Hara, M.. “One Day in the Life of a Very Common Stock.” Review of Financial Studies, 10 (1997), 805–835.CrossRefGoogle Scholar
Easley, D.; O’Hara, M.; and Srinivas, P. S.. “Option Volume and Stock Prices: Evidence on Where Informed Traders Trade.” Journal of Finance, 53 (1998), 431–465.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Figlewski, S., and Webb, G.. “Options, Short Sales, and Market Completeness.” Journal of Finance, 48 (1993), 761–777.CrossRefGoogle Scholar
Finucane, T. “Put-Call Parity and Expected Returns.” Journal of Financial and Quantitative Analysis, 26 (1991), 445–457.CrossRefGoogle Scholar
Gârleanu, N.; Pedersen, L.; and Poteshman, A.. “Demand-Based Option Pricing.” Review of Financial Studies, 22 (2009), 4259–4299.CrossRefGoogle Scholar
Geczy, C.; Musto, D.; and Reed, A.. “Stocks Are Special Too: An Analysis of the Equity Lending Market.” Journal of Financial Economics, 66 (2002), 241–269.CrossRefGoogle Scholar
Giovinazzo, R. “Do Option Prices Contain Information Missing from Stock Prices?” Working Paper, University of Chicago (2008).Google Scholar
Godfrey, L., and Orme, C.. “Testing for Skewness of Regression Disturbances.” Economics Letters, 37 (1991), 31–34.CrossRefGoogle Scholar
Grossman, S. “An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies.” Journal of Business, 61 (1988), 275–298.CrossRefGoogle Scholar
Hansen, L., and Hodrick, R.. “Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis.” Journal of Political Economy, 88 (1980), 829–853.CrossRefGoogle Scholar
Harvey, C., and Siddique, A.. “Conditional Skewness in Asset Pricing Tests.” Journal of Finance, 55 (2000), 1263–1295.CrossRefGoogle Scholar
Hasbrouck, J. “Trading Costs and Returns for US Equities: The Evidence from Daily Data.” Working Paper, New York University (2005).Google Scholar
Holowczak, R.; Simaan, Y.; and Wu, L.. “Price Discovery in the U.S. Stock and Stock Options Markets: A Portfolio Approach.” Review of Derivatives Research, 9 (2006), 37–65.CrossRefGoogle Scholar
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Stock-Market Efficiency.” Journal of Finance, 48 (1993), 65–91.CrossRefGoogle Scholar
John, K; Koticha, A.; Narayanan, R.; and Subrahmanyam, M.. “Margin Rules, Informed Trading in Derivatives, and Price Dynamics.” Working Paper, New York University (2003).Google Scholar
Kamara, A., and Miller, T.. “Daily and Intradaily Tests of European Put-Call Parity.” Journal of Financial and Quantitative Analysis, 30 (1995), 519–539.CrossRefGoogle Scholar
Klemkosky, R., and Resnik, B.. “Put-Call Parity and Market Efficiency.” Journal of Finance, 34 (1979), 1141–1155.Google Scholar
Klemkosky, R., and Resnik, B.. “An Ex Ante Analysis of Put-Call Parity.” Journal of Financial Economics, 8 (1980), 363–378.CrossRefGoogle Scholar
Kumar, R.; Sarin, A.; and Shastri, K.. “The Behavior of Option Price Around Large Block Transactions in the Underlying Security.” Journal of Finance, 47 (1992), 879–889.CrossRefGoogle Scholar
Kyle, A. “Continuous Auctions and Insider Trading.” Econometrica, 53 (1985), 1315–1335.CrossRefGoogle Scholar
Lamont, O., and Thaler, R.. “Can the Market Add and Subtract? Mispricing in Tech Stock Carve-Outs.” Journal of Political Economy, 111 (2003), 227–268.CrossRefGoogle Scholar
Lesmond, D., and Wang, W.. “The Long and the Short of Accrual Based Trading Strategies.” Working Paper, Tulane University (2006).CrossRefGoogle Scholar
Lo, A., and MacKinlay, C.. “When Are Contrarian Profits Due to Stock Market Overreaction?” Review of Financial Studies, 3 (1990), 175–205.CrossRefGoogle Scholar
Manaster, S., and Rendleman, R.. “Option Prices as Predictors of Equilibrium Stock Prices.” Journal of Finance, 37 (1982), 1043–1057.CrossRefGoogle Scholar
Newey, W., and West, K.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.CrossRefGoogle Scholar
Ni, S. X.; Pan, J.; and Poteshman, A. M.. “Volatility Information Trading in the Option Market.” Journal of Finance, 63 (2008), 1059–1091.CrossRefGoogle Scholar
Nisbet, M. “Put-Call Parity Theory and an Empirical Test of the Efficiency of the London Traded Options Market.” Journal of Banking and Finance, 16 (1992), 381–403.CrossRefGoogle Scholar
Ofek, E., and Richardson, M.. “DotCom Mania: The Rise and Fall of Internet Stock Prices,” Journal of Finance, 58 (2003), 1113–1137.CrossRefGoogle Scholar
Ofek, E.; Richardson, M.; and Whitelaw, R.. “Limited Arbitrage and Short Sales Restrictions: Evidence from the Options Markets.” Journal of Financial Economics, 74 (2004), 305–342.CrossRefGoogle Scholar
Pan, J., and Poteshman, A.. “The Information in Option Volume for Future Stock Prices.” Review of Financial Studies, 19 (2006), 871–908.CrossRefGoogle Scholar
Pastor, L., and Stambaugh, R.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), 642–685.CrossRefGoogle Scholar
Petersen, M. “Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches.” Review of Financial Studies, 22 (2009), 435–480.CrossRefGoogle Scholar
Rogers, W. “Regression Standard Errors in Clustered Samples.” Stata Technical Bulletin, 13 (1993), 19–23.Google Scholar
Rubinstein, M. “Edgeworth Binomial Trees.” Journal of Derivatives, 5 (1998), 20–27.CrossRefGoogle Scholar
Stephan, J., and Whaley, R.. “Intraday Price Change and Trading Volume Relations in the Stock and Stock Option Markets.” Journal of Finance, 45 (1990), 191–220.CrossRefGoogle Scholar
Stoll, H. R. “The Relationship between Put and Call Option Prices.” Journal of Finance, 24 (1969), 801–824.CrossRefGoogle Scholar
Tversky, A., and Kahneman, D.. “Advances in Prospect Theory: Cumulative Representation of Uncertainty.” Journal of Risk and Uncertainty, 5 (1992), 297–323.CrossRefGoogle Scholar
Xing, Y.; Zhang, X.; and Zhao, R.. “What Does Individual Option Volatility Smirk Tell Us About Future Equity Returns?” Journal of Financial and Quantitative Analysis, forthcoming (2010).CrossRefGoogle Scholar