What does the SEC choose to investigate?

Abstract

Using a broad sample of merger announcements, I find unusual option volume right before these announcements, an abnormality which provides new information about the pre-merger stock price runup beyond what is incorporated in the stock market. I also find that there exists abnormal option pricing in that the implied volatility spread of target stock options accumulates before merger announcements and leads stock pricing. Moreover, the simultaneity between the volume and pricing effects suggests informed trading about the merger announcements most likely drives both. I further show that trading options immediately before merger announcements is highly profitable. Using a unique sample of merger announcements that have illegal insider trading as released by the SEC, I find that the cumulative abnormal option volume and the profitability of pre-merger option trading are strongly associated with illegal insider trading. Overall, this paper has important implications for the SEC's regulatory efforts to curb illegal insider trading before material corporate information events.