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

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  • Biao Guo
  • Yukun Shi
  • Yaofei Xu

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.

Suggested Citation

  • Biao Guo & Yukun Shi & Yaofei Xu, 2020. "Volatility information difference between CDS, options, and the cross section of options returns," Quantitative Finance, Taylor & Francis Journals, vol. 20(12), pages 2025-2036, December.
    • Handle: RePEc:taf:quantf:v:20:y:2020:i:12:p:2025-2036
    DOI: 10.1080/14697688.2020.1814018
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    Cited by:

    1. Biao Guo & Qian Han & Jufang Liang & Doojin Ryu & Jinyoung Yu, 2020. "Sovereign Credit Spread Spillovers in Asia," Sustainability, MDPI, vol. 12(4), pages 1-14, February.

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