a1 School of Management, Yale University, Box 20820, New Haven, CT 06520. [email protected]
a2 Whitman School of Management, Syracuse University, 721 University Ave., Syracuse, NY 13244. [email protected]
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.
We thank Menachem Brenner, Wayne Ferson (associate editor and referee), John Griffin, Owen Lamont, Tongshu Ma, Paul Malatesta (the editor), Christopher Meredith, Maureen O’Hara, Chayawat Ornthanalai, Allen Poteshman, Matthew Spiegel, Heather Tookes, Nir Yehuda, and seminar participants at Binghamton University, PanAgora Asset Management, the University of Amsterdam, Yale University, and the 2008 European meeting of the Financial Management Association for helpful comments and discussions, and Adam Dix for outstanding research assistance. All errors remain our responsibility.