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Early exercise, implied volatility spread and future stock return: Jumps bind them all

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  • Ian Garrett
  • Adnan Gazi

Abstract

We find that early exercise premiums of exchange‐traded single‐stock American puts, in excess of the GBM‐world premium, can negatively predict future stock returns. Simulations suggest that asset‐value jumps, especially the mean jump‐size, can positively drive this excess premium, while jump‐size can also negatively induce the implied volatility (IV) spread of equivalent American option‐pairs. Empirically, controlling for the effect of jump‐size in excess premiums, the premium loses its predictive power. Furthermore, controlling for the excess premium or jump‐size, IV spreads' predictability shown in the literature also diminishes. Our evidence survives under alternative explanations like informed trading, stock mispricing or market frictions.

Suggested Citation

  • Ian Garrett & Adnan Gazi, 2024. "Early exercise, implied volatility spread and future stock return: Jumps bind them all," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 44(5), pages 720-743, May.
    • Handle: RePEc:wly:jfutmk:v:44:y:2024:i:5:p:720-743
    DOI: 10.1002/fut.22491
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