Call-Put Implied Volatility Spreads, Investor Sentiment, and Option Returns(1/3)

Tremendous studies investigate the information contents and predictability of Call-Put Implied Volatility Spreads (CPIVS) on the future returns of underlying stocks. The representative articles include Bali and Hovakimian (2009), Cremers and Weinbaum (2010), Doran and Krieger (2010), Xing et al. (2010), and Ang et al. (2014). From the above mentioned literature, they generally find that there exists a positive predictability (relationship) between CPIVS and future returns of underlying stocks. The main reason for this finding is that informed traders are more likely to trade in the option markets for realizing their private information. This will result in that CPIVS contain more information about future stock returns. Atilgan (2014) also find that the predictability will become stronger when one takes earning announcement events and some information environments into consideration.However, Doran et al. (2013) find that there exists a negative predictability (relationship) between CPIVS and future call option returns. But, it is still positive predictability for future underlying stock returns. They provide some explanations that the trading demands of unsophistication investors overreact about the market information, for their findings. A number of behavioral theories indicate that investors may form incorrect beliefs and lead to misevaluate assets. On the other hand, some behavioral finance literatures find that investor unsophistication and sentiment play important roles on asset pricing and trading performance. The representative articles include Daniel and Titman (1997), Coval and Shumway (2005), and Mahani and Poteshman (2008).Based upon the above researches, we can conclude that investor sentiment and information invents may have significant impacts on the predictability of CPIVS on future underlying stock returns. Due to lack of literature which take investor sentiment and/or information events into consideration to examine how these two factors affect the CPIVS predictability on future stock and option returns, I hence carry out comprehensive studies on this issue using the individual stock option data. In the first-year project, I will deal with the mass data collecting from OptionMetrics, Compustat and CRSP. Further, I will provide some major descriptive statistics. In the second-year project, I will calculate the key measures (variables), including call-put implied volatility spread, stock returns, sentiment index, and the options returns duringsome information invents as well. Additionally, taking a further step analysis, I will carry out empirical test for how investor sentiment affect the negative relationship between CPIVS and future call option returns.Finally, I will also examine how information events, such as earnings announcements affect the degree of significance for the negative relationship between CPIVS and future call option returns.