Option trading volume by moneyness, firm fundamentals, and expected stock returns

Abstract

I examine the link between option and equity markets by considering the informational content of the option trading volume with respect to moneyness and maturity when the trade direction is unobserved. A high option trading volume of all maturity terms, deep-in-the-money put options, and deep-out-of-the-money call options, predicts higher leverage, increases in default risk, negative earnings surprises, and decreases in future profitability. In addition, option trading volume negatively predicts future stock returns. Information diffusion from the option market to equities plays an important role in accounting for return predictability in option trading volume. Such predictability is less evident in stocks with high institutional ownership and more analyst coverage.