Informed Options Trading Prior to M&A Announcements: Insider Trading?

Abstract

We investigate informed trading activity in equity options prior to the announcement of corporate mergers and acquisitions (M&A), focusing on the target rms. We nd that the probability of informed trading in options during the period just prior to the deal announcement date is much higher than one would expect prior to any randomly chosen date. This is demonstrated by pervasive, unusual option trading volume, implied volatility and liquidity attributes. We document highly positive abnormal trading volumes, excess implied volatility, and higher bid-ask spreads, prior to M&A announcements, with stronger eects for OTM call options on the target company. The probability of option volume on a random day exceeding that of our strongly unusual trading (SUT) sample is trivial - about three in a trillion. These eects are accentuated in the sub-sample of announcements of cash oers for large target rms, particularly in a narrow window before the announcement date. We further document a decrease in the slope of the term structure of implied volatility and an average rise in percentage bid-ask spreads, prior to the announcements. We provide evidence that there is also unusual activity in volatility strategies on the acquirer. We also present a summary analysis of SEC cases involving options trading ahead of M&A announcements, and show that the SEC is more likely to investigate cases where the acquirer is headquartered outside the US, the target is relatively large, and experienced substantial positive abnormal returns after the announcement.