Option-implied volatility measures and stock return predictability

Abstract

Using firm-level option and stock data we examine the predictive ability of option-implied volatility measures proposed by previous studies and recommend the best measure using up-to-date data. Portfolio-level analysis implies significant non-zero risk-adjusted returns on arbitrage portfolios formed on the call-put implied volatility spread implied volatility skew and realized-implied volatility spread. Firm-level cross-sectional regressions show that the implied volatility skew has the most significant predictive power over various investment horizons. The predictive power persists before and after the 2008 Global Financial Crisis. © 2018 Elsevier B.V. All rights reserved.