Abstract
In this paper we investigate the relationship between past trading volume and variance risk premiums (VRPs) around earnings announcement (EAs). Theoretical models suggest opposing relationships between trading volume and VRPs. Using a large sample of straddle returns, we find higher VRPs for firms around EAs with higher trading volume. This relationship holds conditional to other factors suggested to predict VRPs and appears specific to the EA period. Further tests reveal that the result is driven by excess options trading and options trading continues to predict straddle returns conditional on excess stock trading, option open interest, analyst dispersion, and realized earnings surprises. Our main results suggest a one-standard deviation increase in abnormal log options trading volume is associated with a 170 to 190 basis points drop in realized straddle returns around EAs. Finally, we find excess option trading is a stronger predictor of EA option returns for smaller firms and firms with tighter equity bid-ask spreads.
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