Options, equity risks, and the value of capital structure adjustments

Abstract

We use exchange-traded options to identify risks relevant to capital structure adjustments in firms. These forward-looking market-based risk measures provide significant explanatory power in predicting net leverage changes in excess of accounting data. They matter most during contractionary periods and for growth firms. We form market-based indices that capture firms' magnitudes of, and propensity for, net leverage increases. Firms with larger predicted leverage increases outperform firms with lower predicted increases by 3.1% to 3.9% per year in buy-andhold abnormal returns. Finally, consistent with the quality, leverage, and distress risk puzzles, firms with lower predicted leverage increases are riskier but earn lower abnormal returns.

The effects of institutional investor objectives on firm valuation and governance

“…Spread between quarterly average implied volatility from short-term out-of-the-money put options and in-the-money put options. Following Borochin and Yang (2016), used as a measure of cash flow tail risk.…”

“…12 As measured by IV spreadmon, the implied volatility spread across moneyness between OTM and ATM put options. SeeBorochin and Yang (2016) for details on constructing IV spreadmon.…”

What do we know about individual equity options?

“…Furthermore, Jin et al () show that the forecasting power of deviations from put–call parity is particularly high during important firm‐specific information events. Borochin and Yang () argue that the predictive ability of the skewness of the risk‐neutral distribution and deviations from put–call parity stems from the fact that they reflect anticipated future net leverage changes which, in turn, impact future stock returns.…”

“…Furthermore, Jin et al (2012) show that the forecasting power of deviations from put-call parity is particularly high during important firm-specific information events. Borochin and Yang (2017) argue that the predictive ability of the skewness of the risk-neutral distribution and deviations from put-call parity stems from the fact that they reflect anticipated future net leverage changes which, in turn, impact future stock returns. Han and Zhou (2012) investigate the difference between the risk-neutral implied variance and the realized variance, typically referred to as the VRP, as a potential predictor of future stock returns.…”

“…The skewness of the risk-neutral distribution and deviations from put-call parity can predict stock returns Lin and Lu (2015) US [1996][1997][1998][1999][2000][2001][2002][2003][2004][2005][2006][2007][2008][2009][2010] The volatility of the risk-neutral distribution can predict future stock prices, especially during firm-specific events Goyenko et al (2015) US [2004][2005][2006][2007][2008][2009][2010][2011][2012][2013] Option-induced order flows can predict stock returns during periods of option illiquidity Fu, Arisoy, Shackleton, and Umutlu (2016) US 1996-2014 The skewness of the risk-neutral distribution, deviations from put-call parity, and the variance risk premium can predict future stock returns Bernales and Valenzuela (2016) US 1996-2010 The option-implied correlation obtained from 100 stock options (where the underlying stocks are part of the S&P 100 index) is an indicator of market-wide risk and contains information on future market returns Borochin and Yang (2017) US 1996-2012 The skewness of the risk-neutral distribution and deviations from put-call parity can predict future stock returns, due to expected leverage changes Fan, Taylor, and Sandri (2017) US [2003][2004][2005][2006][2007][2008...…”