All are Smart : Do Short Sellers Convey More Information than Option Investors?

We provide a comprehensive comparison of equity short-selling activity and option market activity in predicting future returns. Three variables are constructed, namely the equity short interest ratio (SIR), put-call open interest ratio (PCOIR), and put-call buy volume ratio (PCBVR). The difference between abnormal returns (based on 4-factor risk adjustment model) to the lowest SIR and highest SIR decile portfolios is 1.27% in the first month, while the corresponding differences are 0.91% and 1.78% for PCOIR and PCBVR portfolios, respectively. Based on double-sort portfolio approach and cross-sectional regressions of returns on individual stocks, we find the predictive ability of PCOIR diminishes after controlling for SIR, while the predictive ability of PCBVR persists and even subsumes that of SIR. We find that a high level of institutional ownership will dampen the predictive ability of SIR, and PCOIR and PCBVR as well. While the SIR can predict future returns up to 9 to 12 months, the predictive power might not be all related to information, but simply reflects some omitted firm characteristics