49566225. For helpful comments and discussions, the authors thank Torben Andersen, Snehal Banerjee,

This paper investigates the source of price momentum in the equity market using information from options markets. The empirical results provide direct evidence of the gradual information diffusion model in Hong and Stein (1999). Consistent with their theory, we show that a successful identification of stocks ’ information diffusion stage helps explain momentum profits. We are able to enhance momentum profits by longing winner stocks with higher growth (and shorting loser stocks with larger drop) in call options implied volatility. Our empirical strategy generates a risk-adjusted alpha of 1.8 % per month for a hedged winner-minus-loser portfolio over the 1996–2011 period, during which the simple momentum strategy fails to perform. The results are stronger and clearer if we use call options compared with put options, which are consistent with managers ’ tendency to reveal good news and hide bad news. Our results are robust to transaction costs, choice of options ’ moneyness, elimination of implied volatility per-sistence, and choice of options ’ time-to-maturity. Finally, our results are not driven by existing stock-level characteristics, such as size, trading volume, and analyst coverage