The Joint Cross Section of Option and Stock Returns Predictability with Big Data and Machine Learning

Abstract

Which market has leading informational advantage: stocks or options? Using large set of stock and option characteristics, and machine learning, we provide a comprehensive analysis of which characteristics are the first order importance predictors of options and stock returns. First, we find that options, rather than stock, characteristics are dominant predictors of options returns. Second, options, rather than stock, characteristics are also dominant predictors of stock returns. Consistent with the argument that an increase in trading activity in derivatives decreases information asymmetry about the underlying, options illiquidity is identified as the most important predictor of both stock and options returns.