Do volume spikes in specific equity options signal abnormal returns for underlying stocks? In his June 2016 paper entitled “Investor Attention Strategy”, Xuewu Wang examines the motivation, construction and profitability of a strategy that selects stocks based on sudden attention to associated options. He defines sudden attention as volume spikes of at least 10 contracts after a week of no trades for equity options with minimum bid $0.10 and maturity no longer than 120 days. He further discriminates among option spikes by ranking them into thirds (terciles) based on either: (1) ratio of call volume to total volume; or, (2) call implied volatility minus put implied volatility (matched by strike price and maturity and averaged across all pairs for a given stock). He forms stock portfolios by buying stocks immediately after volume spikes of associated options and holding them for 30 calendar days. Using daily returns and associated option volumes for all U.S. stocks having options during January 1996 through December 2013, he finds that:
- There are 33,579 option volume spikes in the sample, leaning 1.7:1 toward call options and distributed evenly across days of the week.
- On average, stocks outperform the market over the month after volume spikes in associated options. Average outperformance increases with both ratio of call volume to put volume and with call implied volatility minus put implied volatility. Time series top-tercile portfolios of such stocks:
- Beat the market by an average gross annualized 9.1% (7.9%) based on ratio of call volume to put volume (call implied volatility minus put implied volatility).
- Generate gross annualized five-factor [market, size, book-to-market, momentum, liquidity] alpha 8.2% (6.8%) based on ratio of call volume to put volume (call implied volatility minus put implied volatility).
- Results are generally robust to option volume spike based on a 5-contract threshold or a threshold based on number of contracts relative to past 30-day volume, and to a two-week dormant interval.
In summary, evidence indicates that traders may be able to exploit outperformance of stocks that have volume spikes in associated options.
Cautions regarding findings include:
- Performance data are gross, not net. 30-day turnover of selected stocks may result in material trading frictions.
- The number of positions in each stock portfolio varies over time, requiring a cash reserve to assure exploitation of all opportunities. This cash reserve would create a drag on portfolio performance, with magnitude depending on how widely portfolio size fluctuates. Findings do not account for this drag (see “Chapter 6: Modeling at the Portfolio Level”).
- Testing of multiple signals and parameter choices introduces data snooping bias, such that the best-performing variations overstate expectations.
- Data collection/processing burdens are beyond the reach of many investors, who would bear fees for delegation to an investment/fund manager.
