Abstract

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.

Advisor

Tian, Huiting

Second Advisor

Kelvey, Robert

Department

Business Economics; Mathematics

Disciplines

Portfolio and Security Analysis | Statistics and Probability

Keywords

options, implied volatility, stock returns, Black-Scholes model

Publication Date

2021

Degree Granted

Bachelor of Arts

Document Type

Senior Independent Study Thesis

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