Investor Sentiment and Return Predictability of the Option to Stock Volume Ratio

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.