Skip to main content
    • Aa
    • Aa

Deviations from Put-Call Parity and Stock Return Predictability

  • Martijn Cremers (a1) and David Weinbaum (a2)

Deviations from put-call parity contain information about future stock returns. Using the difference in implied volatility between pairs of call and put options to measure these deviations, we find that stocks with relatively expensive calls outperform stocks with relatively expensive puts by 50 basis points per week. We find both positive abnormal performance in stocks with relatively expensive calls and negative abnormal performance in stocks with relatively expensive puts, which cannot be explained by short sale constraints. Rebate rates from the stock lending market directly confirm that our findings are not driven by stocks that are hard to borrow. The degree of predictability is larger when option liquidity is high and stock liquidity low, while there is little predictability when the opposite is true. Controlling for size, option prices are more likely to deviate from strict put-call parity when underlying stocks face more information risk. The degree of predictability decreases over the sample period. Our results are consistent with mispricing during the earlier years of the study, with a gradual reduction of the mispricing over time.

Hide All
Acharya V., and Pedersen L.. “Asset Pricing with Liquidity Risk.” Journal of Financial Economics, 77 (2005), 375410.
Amihud Y. “Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 3156.
Amihud Y.; Mendelson H.; and Lauterbach B.. “Market Microstructure and Security Values: Evidence from the Tel-Aviv Exchange.” Journal of Financial Economics, 45 (1997), 365390.
Amin K.; Coval J.; and Seyhun H. N.. “Index Option Prices And Stock Market Momentum.” Journal of Business, 77 (2004), 835873.
Anand A., and Chakravarty S.. “Stealth Trading in Options Markets.” Journal of Financial and Quantitative Analysis, 42 (2007), 167187.
Andrews D. “Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation.” Econometrica 59 (1991), 817858.
Aslan H.; Easley D.; Hvidkjaer S.; and O’Hara M.. “Firm Characteristics and Informed Trading: Implications for Asset Pricing.” Working Paper, Cornell University (2007).
Back K. “Asymmetric Information and Options.” Review of Financial Studies, 6 (1993), 435472.
Barberis N., and Huang M.. “Stocks as Lotteries: The Implications of Probability Weighting for Security Prices.” American Economic Review, 98 (2008), 20662100.
Battalio R., and Schultz P.. “Options and the Bubble.” Journal of Finance, 61 (2006), 20712102.
Bhattacharya M. “Price Changes of Related Securities: The Case of Call Options and Stocks.” Journal of Financial and Quantitative Analysis, 22 (1987), 115.
Biais B., and Hillion P.. “Insider and Liquidity Trading in Stock and Option Markets.” Review of Financial Studies, 74 (1994), 743780.
Black F. “Fact and Fantasy in the Use of Options.” Financial Analysts Journal, 31 (1975), 3672.
Black F., and Scholes M.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 81 (1973), 637654.
Bollen N., and Whaley R.. “Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?Journal of Finance, 59 (2004), 711753.
Brennan M., and Cao H.. “Information, Trade, and Derivative Securities.” Review of Financial Studies, 9 (1996), 163208.
Brenner M., and Galai D.. “Implied Interest Rates.” Journal of Business, 59 (1986), 493507.
Broadie M.; Chernov M.; and Johannes M.. “Model Specification and Risk Premia: Evidence from Futures Options.” Journal of Finance, 62 (2007), 14531490.
Broadie M.; Chernov M.; and Johannes M.. “Understanding Index Option Returns.” Review of Financial Studies, 22 (2009), 44934529.
Brown S.; Hillegeist S.; and Lo K.. “Conference Calls and Information Asymmetry.” Journal of Accounting and Economics, 37 (2004), 343366.
Cao C.; Chen Z.; and Griffin J.. “The Informational Content of Option Volume Prior to Takeovers.” Journal of Business, 78 (2005), 10731109.
Cao H. “The Effect of Derivative Assets on Information Acquisition and Price Behavior in a Rational Expectations Equilibrium.” Review of Financial Studies, 12 (1999), 131163.
Carhart M. “On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 5782.
Chakravarty S.; Gulen H.; and Mayhew S.. “Informed Trading in Stock and Option Markets.” Journal of Finance, 59 (2004), 12351257.
Chan K.; Chung Y. P.; and Fong W.-M.. “The Informational Role of Stock and Option Volume.” Review of Financial Studies, 15 (2002), 10491075.
Chan K.; Chung Y. P.; and Johnson H.. “Why Option Prices Lag Stock Prices: A Trading-Based Explanation.” Journal of Finance, 48 (1993), 19571967.
Cochrane J. “Asset Pricing: Liquidity, Trading, and Asset Prices.” NBER Reporter, Winter 2004/5 (2005), 112.
Cohen L.; Diether K.; and Malloy C.. “Supply and Demand Shifts in the Shorting Market.” Journal of Finance, 62 (2007), 20612096.
Conrad J.; Dittmar R.; and Ghysels E.. “Skewness and the Bubble.” Working Paper, University of North Carolina at Chapel Hill (2008).
D’Avolio G. “The Market for Borrowing Stock.” Journal of Financial Economics, 66 (2002), 271306.
Duarte J.; Lou X.; and Sadka R.. “Option-Based Hedging of Liquidity Costs in Short Selling.” Working Paper, University of Washington (2005).
Easley D.; Hvidkjaer S.; and O’Hara M.. “Is Information Risk a Determinant of Asset Returns?Journal of Finance, 57 (2002), 21852221.
Easley D.; Kiefer N.; and O’Hara M.. “One Day in the Life of a Very Common Stock.” Review of Financial Studies, 10 (1997), 805835.
Easley D.; O’Hara M.; and Srinivas P. S.. “Option Volume and Stock Prices: Evidence on Where Informed Traders Trade.” Journal of Finance, 53 (1998), 431465.
Fama E. F., and French K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 356.
Figlewski S., and Webb G.. “Options, Short Sales, and Market Completeness.” Journal of Finance, 48 (1993), 761777.
Finucane T. “Put-Call Parity and Expected Returns.” Journal of Financial and Quantitative Analysis, 26 (1991), 445457.
Gârleanu N.; Pedersen L.; and Poteshman A.. “Demand-Based Option Pricing.” Review of Financial Studies, 22 (2009), 42594299.
Geczy C.; Musto D.; and Reed A.. “Stocks Are Special Too: An Analysis of the Equity Lending Market.” Journal of Financial Economics, 66 (2002), 241269.
Giovinazzo R. “Do Option Prices Contain Information Missing from Stock Prices?” Working Paper, University of Chicago (2008).
Godfrey L., and Orme C.. “Testing for Skewness of Regression Disturbances.” Economics Letters, 37 (1991), 3134.
Grossman S. “An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies.” Journal of Business, 61 (1988), 275298.
Hansen L., and Hodrick R.. “Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis.” Journal of Political Economy, 88 (1980), 829853.
Harvey C., and Siddique A.. “Conditional Skewness in Asset Pricing Tests.” Journal of Finance, 55 (2000), 12631295.
Hasbrouck J. “Trading Costs and Returns for US Equities: The Evidence from Daily Data.” Working Paper, New York University (2005).
Holowczak R.; Simaan Y.; and Wu L.. “Price Discovery in the U.S. Stock and Stock Options Markets: A Portfolio Approach.” Review of Derivatives Research, 9 (2006), 3765.
Jegadeesh N., and Titman S.. “Returns to Buying Winners and Selling Losers: Implications for Stock-Market Efficiency.” Journal of Finance, 48 (1993), 6591.
John K; Koticha A.; Narayanan R.; and Subrahmanyam M.. “Margin Rules, Informed Trading in Derivatives, and Price Dynamics.” Working Paper, New York University (2003).
Kamara A., and Miller T.. “Daily and Intradaily Tests of European Put-Call Parity.” Journal of Financial and Quantitative Analysis, 30 (1995), 519539.
Klemkosky R., and Resnik B.. “Put-Call Parity and Market Efficiency.” Journal of Finance, 34 (1979), 11411155.
Klemkosky R., and Resnik B.. “An Ex Ante Analysis of Put-Call Parity.” Journal of Financial Economics, 8 (1980), 363378.
Kumar R.; Sarin A.; and Shastri K.. “The Behavior of Option Price Around Large Block Transactions in the Underlying Security.” Journal of Finance, 47 (1992), 879889.
Kyle A. “Continuous Auctions and Insider Trading.” Econometrica, 53 (1985), 13151335.
Lamont O., and Thaler R.. “Can the Market Add and Subtract? Mispricing in Tech Stock Carve-Outs.” Journal of Political Economy, 111 (2003), 227268.
Lesmond D., and Wang W.. “The Long and the Short of Accrual Based Trading Strategies.” Working Paper, Tulane University (2006).
Lo A., and MacKinlay C.. “When Are Contrarian Profits Due to Stock Market Overreaction?Review of Financial Studies, 3 (1990), 175205.
Manaster S., and Rendleman R.. “Option Prices as Predictors of Equilibrium Stock Prices.” Journal of Finance, 37 (1982), 10431057.
Newey W., and West K.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703708.
Ni S. X.; Pan J.; and Poteshman A. M.. “Volatility Information Trading in the Option Market.” Journal of Finance, 63 (2008), 10591091.
Nisbet M. “Put-Call Parity Theory and an Empirical Test of the Efficiency of the London Traded Options Market.” Journal of Banking and Finance, 16 (1992), 381403.
Ofek E., and Richardson M.. “DotCom Mania: The Rise and Fall of Internet Stock Prices,” Journal of Finance, 58 (2003), 11131137.
Ofek E.; Richardson M.; and Whitelaw R.. “Limited Arbitrage and Short Sales Restrictions: Evidence from the Options Markets.” Journal of Financial Economics, 74 (2004), 305342.
Pan J., and Poteshman A.. “The Information in Option Volume for Future Stock Prices.” Review of Financial Studies, 19 (2006), 871908.
Pastor L., and Stambaugh R.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), 642685.
Petersen M. “Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches.” Review of Financial Studies, 22 (2009), 435480.
Rogers W. “Regression Standard Errors in Clustered Samples.” Stata Technical Bulletin, 13 (1993), 1923.
Rubinstein M. “Edgeworth Binomial Trees.” Journal of Derivatives, 5 (1998), 2027.
Stephan J., and Whaley R.. “Intraday Price Change and Trading Volume Relations in the Stock and Stock Option Markets.” Journal of Finance, 45 (1990), 191220.
Stoll H. R. “The Relationship between Put and Call Option Prices.” Journal of Finance, 24 (1969), 801824.
Tversky A., and Kahneman D.. “Advances in Prospect Theory: Cumulative Representation of Uncertainty.” Journal of Risk and Uncertainty, 5 (1992), 297323.
Xing Y.; Zhang X.; and Zhao R.. “What Does Individual Option Volatility Smirk Tell Us About Future Equity Returns?Journal of Financial and Quantitative Analysis, forthcoming (2010).
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Journal of Financial and Quantitative Analysis
  • ISSN: 0022-1090
  • EISSN: 1756-6916
  • URL: /core/journals/journal-of-financial-and-quantitative-analysis
Please enter your name
Please enter a valid email address
Who would you like to send this to? *


Full text views

Total number of HTML views: 1
Total number of PDF views: 385 *
Loading metrics...

Abstract views

Total abstract views: 1098 *
Loading metrics...

* Views captured on Cambridge Core between September 2016 - 22nd October 2017. This data will be updated every 24 hours.