Distilling private information from plain-vanilla options to predict future underlying stock price volatility: Evidence from the H-shares of Chinese banks

Deviations from put-call parity may arise in response to private information that a select group of investors possess. From a practical perspective, if one possesses private information, using options to speculate or hedge amplifies potential gains given the leverage embedded in options with respect to price changes in the underlying asset. In light of this, and if we assume that the average investor does not possess private information, it is perhaps possible though to infer such information through implied variance spreads and use it to predict future volatility in the underlying asset. In this piece I examine the extent to which such information is economically informative in predicting the intraday return variability of H-shares issued by China's state and joint-stock banks, respectively. Generally speaking, I uncover the following; firstly, call-put implied variance spreads are mean-reverting across time. Secondly, at any given point in time, the magnitude of the deviation from put-call parity is informative in predicting rises in future spot price volatility. Thirdly, straddle/strangle trades predict, at times one week in advance, rises in future spot price volatility. These findings hold after controlling for market-wide implied volatility, the flow and shock in information disseminating to the market, and implicit transactions costs.