Thread by @ReformedTrader

1/ Why Do Price and Volatility Information from the Options Market Predict Stock Returns? (Muravyev, Pearson, Pollet)

"Findings suggest that the IV spread [ATM puts & calls] and skew predict returns because they proxy for expected stock borrowing costs."

papers.ssrn.com/sol3/papers.cf…

2/ "The implied volatility spread is the average difference of the implied volatilities of the available calls and puts with the same strike price and expiration date.

"The IV skew is the difference between the IVs of an out-of-the-money put and an at-the-money call."

3/ "The high correlations between option-implied and
indicative fees suggest that the option-implied borrowing fees can be useful proxies for the actual stock borrowing fees faced by a marginal investor."

4/ "The option-implied fee for AIG appears to be the indicative fee plus noise.

"Our approach also provides a way to estimate stock borrowing costs starting from 1996, well before the first date for which daily data on indicative stock borrowing fees are available from Markit."

5/ "We report market-adj returns when sorting stocks using option-implied borrowing fee, indicative borrowing fee, average IV difference between same-strike puts and calls, and vertical skew.

"Return differentials are due largely to low returns for stocks in the tenth decile."

6/ "Forming the decile portfolios using all four sorting variables results in similar patterns of returns [both before and after risk adjustment using MKT_RF, SMB, HML, UMD, RMW, CMA, and ST_REV].

"We hypothesize that the four variables capture the same underlying factor."

7/ "The first PC largely captures measures of the volume of short-selling activity. The second PC mostly captures measures of the cost of short-selling.

"Evidence suggests that the volatility spread and skew do not provide explanatory power beyond the implied borrowing fee."

8/ "Since implied borrowing fee remains a useful predictor for stocks with low option volume, explanations related to options market price pressure appear to be irrelevant.

"Results are consistent with the volatility spread and skew proxying for expected cost to borrow stocks."

9/ "Volatility spread and skew do not predict monthly returns in any of the subsamples, even for high option volume, presumably when demand pressure is most relevant.

"Overall, the result that the implied borrowing fee predicts returns is robust across samples and time periods."

10/ "Both implied and indicative fees are significant predictors of the change in the borrowing fee. The coefficient on the implied borrowing fee is positive, as anticipated. The coefficient on the indicative fee is negative, consistent with a mean-reverting process."

11/ "The returns of the 10-1 strategy after adjusting for borrowing fees are statistically significant at conventional levels in three of the four panels of Table 9.

"The magnitudes of these averages are only roughly half (41% to 57%) of the magnitudes in Table 3."

12/ "After factor risk-adjustment, the returns for portfolio 10 are similar to the average market-adjusted returns for portfolio 10 in Table 9.

"The 10-1 differentials are not statistically significant for the indicative fee and only marginally significant for IV skew."

13/ "We consider seven other variables related to borrowing stock and/or short sales.

For stock returns, "the implied borrowing fee is an important predictor beyond other measures of short selling activity, but these other measures do collectively capture useful information."

14/ "Other literature uses fees received by ultimate lenders and concludes that the net returns to shorting remain large.

"Our results differ: we use fees paid by ultimate borrowers [hedge funds, option market makers], who pay the substantial markups charged by prime brokers."

15/ Related research:

Equity Factors: To Short Or Not To Short, That is the Question

https://twitter.com/ReformedTrader/status/1252013541487304707

The Loan Fee Anomaly: A Short Seller's Best Ideas

https://twitter.com/ReformedTrader/status/1324519224279064576

Shorting Costs and Profitability of Long–Short Strategies

https://twitter.com/ReformedTrader/status/1249502722253971457

16/ Borrowing Fees and Expected Stock Returns

https://twitter.com/ReformedTrader/status/1328467331916316674