Informed Trading in the Options Market and Stock Return Predictability

Previous research highlights the importance of two distinct types of informed trading in the options market: trading on the price direction of underlying stocks, and trading on their uncertainty. Surprisingly, however, the studies considering these in a unified framework are scant. This study attempts to fill the gap. We predict that when both directional and volatility information could motivate options trading, the return predictability of options volume hinges on the shape of the volatility smirk. Consistent with this prediction, we find that the negative relationship between options volume and future stock returns is concentrated in stocks exhibiting steep volatility smirks. © 2017 Wiley Periodicals, Inc. Jrl Fut Mark 37:1053–1093, 2017