Option markets are a fascinating area of study and in recent years research has indicated that information obtained from the options market can be used to explain price returns in the underlying stock market. Building on existing asset pricing models such as the Fama-French Three Factor, Carhart Four Factor, and Fama-French Five Factor Models, this research tests if the put to call ratio can be used as an additional factor in explaining excess returns. Ordinary least squares models are run on all Dow Jones 30 stocks using more than ten years of data and the model results are compared. The results conclude that in a majority of cases, asset pricing models which include the ratio of put options to call options better explain excess stock returns than models which do not include information from the options market. These results provide supporting evidence that information from the options market contains valuable information into underlying stock price performance.
Recommended CitationGough, Michael, "Explaining Excess Stock Return Through Options Market Sentiment" (2018). Honors Projects in Finance. Paper 40.