Study: Borrowing fee is the variable that debunks theory that options predict future stock returns

By Mike Koon

“If you want to beat the market, you need to have some information that other people don’t,” said Dmitriy Muravyev, associate professor of finance at Gies College of Business.  

Transformations of options prices, such as the implied volatility spread, have been used by academics analyzing the stock market to predict future stock returns with amazing success in back-testing exercises. This pattern has been attributed to sophisticated investors buying "put options" so that they become more expensive relative to "call options" when subsequent stock returns are likely to be low. However, in practice, this stock return predictability, based on public information in options markets, is a mirage that is not readily exploitable in the real world.

Muravyev and two Gies Business colleagues, Joshua Pollet, professor of finance and Seass Faculty Fellow, and Neal Pearson, Harry A. Brandt Distinguished Professor of Financial Markets and Options, collaborated on a study to find out why. The research team realized that to explain the lack of success in practice, there had to be a transaction cost or a friction that the academic approach was missing.

They found that the stock borrow fee is the hidden friction.

They released their findings in “Why does options market information predict stock returns?” which was published in the October 2025 issue of the Journal of Finance Economics.

Without considering the stock borrow fee, an investor can identify which stocks are likely to have low returns and sell them short based on options data. However, when an investor shorts the stock to profit from the trade if the stock price decreases, then the investor must borrow the shares from another participant. That third party must be compensated for lending the shares to the investor. This compensation is the stock borrow fee. However, most retail investors, who sell short to attempt to beat the market, cannot easily detect the fee in the stated stock return on popular platforms like Yahoo Finance.

This study found that to implement these strategies based on options prices by selling short, investors would routinely incur high stock borrow fees, and thus the performance of the strategies re much closer to zero. It’s the stock borrow fee that explains why the stock return predictability persists even though sophisticated investors cannot gain a large advantage.

“This missing fee is difficult to observe unless you are actually implementing short sale transactions and/or are a sophisticated player that is really paying attention to this fee,” Pollet explained. “The relationship between the prices of the two options and the underlying asset and the bond should hold perfectly in the absence of some other friction. This is known as put-call parity. Because people don’t actually use option prices when they think about the data, and instead use the implied volatilities, the novel approach here is to translate the relation between the stock price and the option prices into a discussion about implied volatilities of puts and calls. The gap between the two implied volatilities reveals the borrow fee.”

Even the data from the Center for Research and Securities Prices (CRSP) – the major vendor for research-quality financial and economic data to academic, commercial, and governmental institutions – doesn’t include the stock borrow fee in its data.

“If you are calculating returns and trying to figure out what the true cost for selling something short, that data is not readily available to retail investors,” Pollet said. “You would pay it if you’d implemented the transaction in the real world, but anyone back-testing a strategy without access to this fee data is going to miss the impact of this fee. Until now, it has been assumed that this fee doesn’t matter much, but we discovered, as it turns out, that for this subset of stocks for which the option prices are useful for computing returns, it is a large component of the difference in the predicted return and the actual return.”

“You need to think of the stock borrow fee like a shadow dividend,” Muravyev added. “If you disregard the dividend yield when you buy stocks, then some companies will look inherently cheaper or inherently more expensive. In the same way, if you look at the stock options and disregard the stock borrow fee like a shadow dividend, the same applies. A retail investor would not normally notice this fee, unlike an actual dividend.”

Although the team was confident in their discovery, Pearson discussed their finding with a relatively high-level individual in charge of option metrics, who validated their result.

Before the Internet age, knowledge of stock option transactions might have given sophisticated investors a slight edge. However, since that information is publicly available in real time today, this data no longer provides an advantage.

“There are so many smart people with so much technology that have access to real-time information today,” Muravyev said. “In the 1980s, when there was an options transaction, it might have been public in hours; now it’s milliseconds. Today, if you are working for a hedge fund, this information could be useful, but it is not easy money like the many academics have tried to paint it.”

“In general, it’s possible that some people can beat the market some of the time with a lot of work, but it should be really difficult,” Pollet said. “If something is so straightforward, can be done with public information, and able to outperform the market by 10 percent per year, surely someone else should already be doing that,” Pollet reiterated. “There had to be something that the academic approach was missing that made it look so good, and the answer we found is the stock borrow fee. Once you consider the additional cost, a lot of what looked good actually disappears.”

Although these patterns had to be explained, the fact that the options market information is not that valuable for trading strategies is not surprising to the research team.

“The traditional view would be that all these markets are integrated in terms of information and efficiency, and information is rapidly entering into both stock and option prices at roughly the same time,” Pollet explained. “So, it is surprising that information in one market would somehow predict performance of returns in a different market.”

The research team believes their discovery not only can be applied to option analysis, but the stock borrow fee might also explain other stock anomalies, which have been used to predict returns.

“To take advantage of these anomalies, you’re going to have to short sell the stocks,” Muravyev said. “Once you sell those stocks, you will pay the stock borrow fee. Once you account for the shadow dividend of the stock borrow fee, it is not actually profitable.”

“While most stocks have relatively low borrow fees (only 10 percent have a fee of two percent or more), our advice is if you see stocks with high borrow fees, don’t hold those stocks,” Pollet said.