Volatility information difference between CDS, options, and the cross section of options returns

Guo, B., Shi, Y. and Xu, Y. (2020) Volatility information difference between CDS, options, and the cross section of options returns. Quantitative Finance, 20(12), pp. 2025-2036. (doi: 10.1080/14697688.2020.1814018)

Abstract

We examine the difference in the information content in credit and options markets by extracting volatilities from corporate credit default swaps (CDSs) and equity options. The standardized difference in volatility, quantified as the volatility spread, is positively related to future option returns. We rank firms based on the volatility spread and analyze the returns for straddle portfolios buying both a put and a call option for the underlying firm with the same strike price and expiration date. A zero-cost trading strategy that is long (short) in the portfolio with the largest (smallest) spread generates a significant average monthly return, even after controlling for individual stock characteristics, traditional risk factors, and moderate transaction costs.

• Item Type: Articles
• Additional Information: Biao Guo acknowledges the support by the Fundamental Research Funds for the Central Universities and the Research Funds of Renmin University of China [grant number 16XNA001].
• Status: Published
• Refereed: Yes
• Glasgow Author(s) Enlighten ID: Shi, Dr Yukun and Xu, Mr Yaofei
• Authors: Guo, B., Shi, Y., and Xu, Y.
• College/School: College of Social Sciences > Adam Smith Business School; College of Social Sciences > Adam Smith Business School > Accounting and Finance
• Journal Name: Quantitative Finance
• Publisher: Taylor and Francis
• ISSN: 1469-7688
• ISSN (Online): 1469-7696
• Published Online: 15 October 2020
• Copyright Holders: Copyright © 2020 Informa UK Limited, trading as Taylor & Francis Group
• First Published: First published in Quantitative Finance 20(12): 2025-2036
• Publisher Policy: Reproduced in accordance with the copyright policy of the publisher