### Using OTM Equity Options Volume to Predict Stock Returns

**July 21, 2016** - Equity Options

Does trading of out-of-the-money (OTM) equity options expose exploitable private information? In their July 2016 paper entitled “Stock Return Predictability of Out-of-the-Money Option Trading”, Chang Mo Kang, Donghyun Kim and Geul Lee investigate relationships between OTM option trading volume and future returns of underlying stocks. They define OTM based on a range of option deltas and normalize OTM volume by dividing by total option volume for a stock. They first test the power of normalized OTM put and call volumes to predict stock returns at a daily frequency. They then test the power of the OTM put-call volume ratio (OTM put volume divided by all OTM option volume) to predict stock returns at daily and weekly frequencies. Finally, they test a hedge strategy that is each week long (short) the ranked tenth, or decile, of stocks with the lowest (highest) prior-week put-call volume ratios. Using daily and weekly data for relatively liquid near-term options and returns for underlying stocks during 1996 through 2015, *they find that:* Keep Reading