Why Do Option Prices Predict Stock Returns? The Role of Price Pressure in the Stock Market

Luis Goncalves-Pinto, Bruce D. Grundy, Allaudeen Hameed, Thijs van der Heijden, Yichao Zhu

Forthcoming, Management Science

Stock and options markets can disagree about a stock's value because of informed trading in options and/or price pressure in the stock. The predictability of stock returns based on this cross-market discrepancy in values is especially strong when accompanied by stock price pressure, and it does not depend on trading in options. We argue that option-implied prices provide an anchor for fundamental stock values that helps to distinguish stock price movements due to pressure versus news. Overall, our results are consistent with stock price pressure being the primary driver of the option price-based stock return predictability.

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