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We study the effect of investor sentiment on the relation between the option to stock volume ratio (O/S) and future stock returns. Relative option volume has return predictability under short sale constraints. For this reason, we expect and find a stronger O/S‐return relation during high sentiment periods than during low sentiment periods. We find that Baker and Wurgler's Investor Sentiment Index affects the O/S‐return relation after controlling for consumer sentiment indices and economic environment factors. While prior studies have used consumer sentiment indices as alternative measures of investor sentiment, our results suggest these effects are distinct.

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This study investigates the cross‐sectional implication of informed options trading across different strikes and maturities. We explore the term structure perspective of the one‐way information transmission from options markets to stock markets by adopting well‐known option‐implied volatility measures to examine stock return predictability. Using equity options data for U.S. listed stocks spanning 2000–2013, we find that the shape of the long‐term implied volatility curve exhibits extra predictive power for stock returns of subsequent months even after orthogonalizing the short‐term components. Our findings indicate that the inter‐market information asymmetry rapidly disappears before the expiration of long‐term option contracts.

This research studies the effect of stock-level investor sentiment on individual stock returns’ mean-variance relation. Using unique buy and sell volume data of retail investors in Korean stock market, we find that a positive mean-variance relation is undermined among high-sentiment stocks, but holds among low-sentiment stocks. We adopt buy-sell imbalances of retail investors for individual stocks as a measure of stock-level investor sentiment. Further, our findings provide empirical evidence of a strong riskreturn trade-off among stocks with low retail concentration (e.g., large capitalization, high-priced, and growth stocks). Existing research only analyzes market-wide investor sentiment. However, we study the effect of stock-level investor sentiment on individual stock returns. Therefore, our findings suggest novel implications about the investment strategy that the stock-level investor sentiment is important when constructing portfolios based on variance.