Prior literature shows that implied volatility spreads between call and put options are positively related to future underlying stock returns. In this paper, however, we demon- strate that the volatility spreads are negatively related to future out-of-the-money call option returns. Using unique data on option volumes, we reconcile the two pieces of evidence by showing that option demand by sophisticated, firm investors drives the posi- tive stock return predictability based on volatility spreads, while demand by less sophis- ticated, customer investors drives the negative call option return predictability. Overall, our evidence suggests that volatility spreads contain information about both firm funda- mentals and option mispricing.

This paper studies the presence of informed trading in Taiwan stock index options (TXO) and analyzes the informational role of foreign institutions in incorporating information into Taiwan stock index futures (TX). We have found that only the option-induced part (OOI) of the total TX order imbalance can predict future TX prices, and the OOI calculated from open-buy TXO, defined by Ni et al. (2008), provides incremental predictability. This finding shows that the price predictability stems from the information flow resulting from option transactions rather than from liquidity pressure. We conclude further that option transactions from foreign institutions provide the most significant predictability, out-of-the-money option transactions in particular. These empirical results show that option transactions conducted by foreign institutions have played the primary role in conveying the information inherent in the TXO market to the TX market, foreign institutions being delta-informed traders. Retail investors, the major players in both the TXO and TX markets, have done almost nothing of significance with regard to TXO information transmission into the TX market, with the exception of some near-the-money and out-of-the-money options.