We study the cross-section of realized stock option returns and find an economically important source of predictability in the cross-sectional distribution of implied volatility. A zero-cost trading strategy that is long (short) in straddles with a large positive (negative) forecast of the change in implied volatility forecast produces an economically important and statistically significant average monthly return. The results are robust to di_erent market conditions,to firm risk-characteristics,to various industry groupings,to options liquidity characteristics,and are not explained by linear factor models. Compared to the market prediction,the implied volatility estimate obtained from the cross-sectional forecasting model is a more precise and efficient estimate of future realized volatility.
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