Betting Against the Crowd: Option Trading and Market Risk Premium

Jie Cao, Gang Li, Xintong (Eunice) Zhan, and Guofu Zhou

♦ We examine time-series stock market excess return predictability by aggregate stock option order imbalance. While individual-level call order imbalance (CIB) captures informed trading and positively predicts cross-sectional stock returns, we show that aggregate call order imbalance (ACIB) serves as a potent sentiment signal. Aggregation diversifies away firm-specific news, revealing a dominant sentiment component that negatively forecasts the U.S. market risk premium. This predictability is driven by small-volume traders and is most pronounced during high-sentiment periods, underscoring the dual nature of option trading as both an informed-trading and sentiment-driven signal.

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