Since the trading of options is based on underlying stocks, it is reasonable to assume that information from the options market can be used to explain the returns in the stock market. Our independent study investigates the relationship between options implied volatility and stock returns. Previous studies have found significant results in using implied volatility in predicting stock returns. This paper provides a discussion of such studies, the theoretical framework for the research topic, and the Black-Scholes model, which is famous for its application in implied volatility calculation. Monthly returns of 20 large US firms are regressed against implied volatility and other control variables, using fixed-effect and Fama-Macbeth regression. The result from these regressions suggests that implied volatility level is useful in predicting the time-series returns of stock, while the put-call implied volatility spread is significant in explaining cross-sectional stock returns. The results of our paper support previous literature's findings, which suggest that information from implied volatility is useful in predicting stock market returns.
Business Economics; Mathematics
Dao, Hung T., "Option Implied Volatility's Predictability on Monthly Stock Returns" (2021). Senior Independent Study Theses. Paper 9305.
Portfolio and Security Analysis | Statistics and Probability
options, implied volatility, stock returns, Black-Scholes model
Bachelor of Arts
Senior Independent Study Thesis
© Copyright 2021 Hung T. Dao