Option Trading Activity Research Articles

Corporate insider purchases and the options market: Competition among informed investors

Corporate insiders have superior access to information; their trades, particularly purchases, should be informative. However, the extent of their informational advantage may be limited by the presence of other informed market participants. We document less frequent insider purchases in stocks with relatively high options trading activity. These purchases are followed by negligible abnormal returns. In contrast, stocks with less active options trading experience more frequent insider purchases, which yield positive abnormal returns over the subsequent six months. Our novel approach highlights the options market's role in screening uninformed insider trades, which ultimately contributes to more efficient stock market price formation.

To Change or Not to Change: The Informativeness of REIT Annual Reports

Increasingly similar corporate disclosures may fail to provide potential investors with adequate information about a company to facilitate astute, informed, and/or rational decision making. In light of this repeatedly expressed SEC concern, the current investigation uses a sample of 1,910 annual report (10-k) filings by 234 separate equity REITs from 2000-2020 to examine the impact of year-over-year linguistic similarity on the perceived information content of corporate disclosures. Consistent with the aforementioned concerns, we document a significant increase in the degree of REIT annual report similarity over time. Despite this trend, we find that innovations in annual report disclosures remain directly related to observable changes in both the operational complexity and financial position of the firm. Furthermore, these innovations engender significant market reactions including changes in options trading activity, annual report readability, and the firm’s cost of equity capital. Lastly, these findings are both robust to the inclusion of alternative information channels and are significantly more pronounced within informationally opaque market settings. In sum, we find REIT annual reports remain a value-relevant source of information for market participants.

Option trading activity and capital reallocation efficiency: Evidence from corporate restructurings

We examine whether option trading enables firms to restructure more efficiently and thus achieve better economic outcomes. We find that more option trading is associated with greater operating performance and higher firm value in the years following restructuring, after controlling for other determinants of performance and value. The central findings survive the consideration of endogeneity. Our results suggest that option trading produces a feedback effect that allows for a more economically efficient allocation of capital.

Martingale defects in the volatility surface and bubble conditions in the underlying

AbstractThe martingale theory of bubbles enables testing for asset price bubbles by analyzing option prices. As recently shown by Piiroinen et al. (Asset price bubbles: an option-based indicator, 2018), the SABR model is a strict local martingale when its parameterization implies a positive correlation between stock and option prices. We operationalize this theoretical result and analyze stock price bubbles in 2576 stocks over 26 years. Martingale defect conditions are absorbed quickly by options markets, but identify high proportions in significant and permanent changes in distribution of price returns, option trading activity, short interest in the underlying, and institutional ownership. These results confirm many common assumptions about stock price bubbles. These bubbles are temporally clustered, and tend to occur in periods of positive market development. Martingale defects are rare in market corrections, which indicates that they are a result of overoptimistic speculation.

Do Credit Rating Agencies Learn from the Options Market?

Do credit rating agencies (CRAs) learn from the options market? We examine this question by exploring the relation between options trading activity and credit rating accuracy. We find that as options trading volume increases, credit ratings become more responsive to expected credit risk and exhibit greater ability to predict future defaults. We also find that CRAs rely more on the options market as a source of ratings-related information when firm default risk is higher, options trading is more informative, manager-provided information is of lower quality, and firm uncertainty is higher. Our results are robust to a number of sensitivity tests, including alternative measures of options trading and credit rating accuracy. We reach similar inferences using various approaches to address endogeneity issues, including difference-in-difference analyses and an instrumental variables approach. Overall, our findings are consistent with the view that CRAs incorporate unique information from the options market into their rating decisions which, in turn, improves credit rating accuracy. This paper was accepted by Brian Bushee, accounting. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2023.4980 .

Options trading and earnings management: Evidence from the penny pilot program

Using a difference-in-differences approach that relies on the exogenous increase in options trading activity generated by the Securities and Exchange Commission's Penny Pilot Program, we find a negative causal effect of options trading on earnings management. With a reduced magnitude of discretionary accruals, the pilot firms are less likely to marginally beat earnings targets and less likely to have financial misstatements during the pilot period. Cross-sectional analysis shows that the effects are more pronounced among firms with a small or less independent board or a small audit committee. Furthermore, the pilot firms receive more market attention, and their stock price efficiency improves more than the nonpilot firms during the pilot period. The evidence is consistent with the argument that active options trading enhances market scrutiny of firms' reporting behavior, improving financial reporting quality and price efficiency.

Option Trading Activity, News Releases, and Stock Return Predictability

We examine which categories of option trading volume carry information about future stock prices around corporate news announcements. We predict and find that purchases of options are informative on news days and ahead of unscheduled events but not before scheduled events, and sales of options predict returns only ahead of scheduled news releases. Therefore, although the arrival of new information is an important reason why option volume predicts stock returns, this relation depends on whether the information is scheduled or unscheduled because only the former affects volatility and thus option prices. We also study how trading costs and margin costs affect ex post profitability around news. This paper was accepted by Karl Diether, finance. Funding: D. Weinbaum gratefully acknowledges research support from the Harris Fellowship in Finance. Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2022.4543 .

Does Options Trading Activity Benefit REITs?

Options trading on Real Estate Investment Trusts (REITs) has grown exponentially over the past two decades. This article investigates whether, and to what extent, higher levels of active options trading activity materially influence REIT financial market performance. Using a sample of 224 equity REITs, over the period 1996 through 2019, we found REITs with higher levels of options trading activity persistently exhibit enhanced valuations and financial market liquidity. We further found the positive impact of options trading activity on REIT value is not driven by the positive association between options trading activity and market liquidity, but rather is primarily attributable to the enhanced informational efficiency induced by options trading. Taken together, these results provide compelling evidence of the potential benefits of options trading for publicly listed REITs.

Reluctant Investors: A Behavioral Experiment

Private wealth managers are often challenged to help reluctant clients make investment decisions in nondiscretionary accounts. Investors may be hesitant, or even too eager, about the price and timing of specific investments. This investor behavior challenges wealth managers on a daily basis. We designed an experiment to seek out remedies in the setting of a university student–managed investment fund with novice undergraduate student investors. Over 3 years, more than 400 investment decisions were made. More than 220 decisions would not have been made were it not for our suggested remedy. Our sample includes more than 100 individual investors and a portfolio size of $1 million in real funds. Our solution for hesitancy is offering cash covered puts for investment purchases and covered calls for investment liquidations. We find that having a third option of buying or selling with covered options largely alleviates decision-making anxiety for our sample investors. As a bonus, this option trading activity made the portfolio significantly more profitable during this 3-year experimental period from 2017 through 2019.

Informed options trading prior to FDA announcements

AbstractWe find that pre‐announcement implied volatility spreads and options trading activity are abnormally elevated and can predict Food and Drug Administration (FDA) announcement date stock returns. The effect is more pronounced in firms with higher levels of information asymmetry and lower‐quality corporate governance suggesting that some options traders are informed in advance of the details that affect the stock price impact of the FDA news. We provide the first examination of informed options trading prior to FDA announcements during a 21‐year period. Our findings have implications for regulators, investors and relevant firms.

Speculation or hedging?—Options trading prior to FOMC announcements

AbstractThis paper investigates options trading activity before Federal Open Market Committee (FOMC) announcements. We find evidence that informed traders use options to speculate on their private information for the upcoming FOMC announcements. Specifically, abnormal trading volume of call options on S&P 500 index during the preannouncement window positively predicts postannouncement index returns, and this predictability mainly comes from near‐the‐money call options. Moreover, we further break down trading volume based on the direction of trades and show that buyer‐initiated call option trading volume positively predicts postannouncement index returns. We find no evidence that investors use options to hedge postannouncement market uncertainty.

Does Options Trading Deter Real Activities Manipulation?

We examine whether and how options trading activity curtails real activities manipulation. Using a large sample of US firms that are suspected of earnings manipulation, we document that an active options trading market significantly reduces real activities manipulation. We confirm our findings by using 2SLS analyses and alternative research designs. Our findings are also robust to using alternative proxies for options trading activity. Further, we find that the deterring impact of options trading on real activities manipulation is more pronounced among firms with low institutional ownership, firms in highly competitive industries, and small and young firms. Overall, our findings show that an active options market discourages managers from engaging in real activities manipulation as informed options trading helps stock prices better reflect adverse consequences of real activities manipulation. Our findings highlight the benefits of the options market development in reducing value-destroying activities and thus provide policy, practice, and research implications.

Options Trading Activity and the Efficiency of Corporate Investment

We examine the relation of active options market trading and the (in)efficiency of corporate investment in terms of deviation from optimal investment levels. Past research considers the volume of options trading as contributing to firms’ informational efficiency. Investment efficiency is partly driven by information asymmetries between firm managers and capital providers, aggravating moral hazard concerns. We test whether the enhancement in firms’ information environment associated with higher volume of options trading activity is positively related to optimizing investment at the firm level. Our results indicate that the volume of options trading by firms is positively and significantly associated with firm-level investment efficiency. This relation is associated with the enhancement in the firms’ information environment stemming from active options trading. Overall, our findings suggest that the managerial skills associated with active trading in derivatives markets also benefit firms’ investment decisions through enhancing the optimal allocation of firm resources and investment efficiency.

Options Trading and Corporate Debt Structure

Options trading activity can affect firm debt structure decisions by stimulating informed trading that improves the informational environment in which firms raise debt capital. We find supporting evidence, at both the extensive and intensive margin, that firms with actively traded options are able to shift from bank to public debt financing. We provide cross-sectional evidence that the shift from bank financing reflects reduced demand for the special role that banks play in ex ante information collection and ex post monitoring for firms with greater information asymmetry. Instrumental variable analysis and three quasi-natural experiments support a causal interpretation of our findings.

Information Leakage in Energy Derivatives around News Announcements

We examine the behavior of US crude oil and natural gas futures options implied volatility based measures as proxies for information leakage around news announcements between 2007 and 2017. In the five days preceding news releases, we report abnormal changes in the levels of futures options implied volatility spreads and skew. In addition, we report a statistically significant relationship between abnormal announcement date returns and abnormal changes in pre-announcement implied volatility spreads/skew. Our findings indicate that at least some investors are informed about the details of future crude oil and natural gas news. TOPICS:Options, derivatives Key Findings • The study offers a unique examination of information leakage in crude oil and natural gas futures options prior to commodity specific news between 2007 to 2017. • We report abnormal changes in implied volatility spreads and skew in the five days prior to news announcements. • Pre-announcement abnormal options trading activity indicates that some traders have knowledge about the details of upcoming energy news.

Informed Options Trading Around U.S. FDA Announcements

We provide the first examination of informed options trading around US Food and Drug Administration announcements between 1996 and 2016. Using implied volatility spreads and options trading volume, we find that informed traders are aware of the timing of the news at least five days in advance, and at least some informed traders have knowledge of the details which affect the price impact of the announcement. Such findings are more prevalent in firms with higher levels of information asymmetry and lower quality corporate governance, suggesting insider trading as a possible source of the abnormal options trading activity. Our findings have implications for regulators, investors, and relevant firms.

Show Me the Money: Option Moneyness Concentration and Future Stock Returns

Informed traders often use options that are not in-the-money due to higher potential gains for a smaller upfront cost. Thus, trading activity by option moneyness should be a gauge of informed option trading. We construct a dollar volume-weighted average moneyness measure to capture option trading activity at different moneyness levels. Stock returns increase with this measure, suggesting more trading activity in options with higher leverage predicts future stock returns. Our results hold cross-sectionally and at the portfolio level yielding a Fama-French five-factor alpha of 12% per year for all stocks and 33% per year for high implied volatility stocks.

Show me the money: Option moneyness concentration and future stock returns

AbstractInformed traders often use options that are not in‐the‐money due to higher potential gains for a smaller upfront cost. Thus, trading activity by option moneyness should be a gauge of informed option trading. We construct a dollar volume‐weighted average moneyness measure to capture option trading activity at different moneyness levels. Stock returns increase with this measure, suggesting more trading activity in options with higher leverage predicts future stock returns. Our results hold cross‐sectionally and at the portfolio level yielding a Fama–French five‐factor α of 12% per year for all stocks and 33% per year for high implied volatility stocks.

The effects of liquidity trading on insider trade timing when an underlying option is present

PurposeThe purpose of this paper is to examine whether the underlying option impacts an insider’s propensity to purchase and sell before corporate announcements, the proportion of insiders’ trading after announcements relative to before announcements, and the insider’s profitability around corporate announcements.Design/methodology/approachThe authors test whether the timing information and option have impacted on the tendency of insider trade, the percentage of all shares traded by insiders in the post-announcement to pre-announcement periods and the average cumulative abnormal stock returns during the pre-announcement period.FindingsInsiders’ propensity to trade before announcements is higher for stocks without options listed than for stocks with traded options. This result is stronger for unscheduled announcements than for scheduled ones. The proportion of insiders’ trade volume after announcements relative to before announcements in stocks that have not options listed is higher than those in stocks with traded options. The positive relationship between the insiders’ signed volume and the informational content of corporate announcements is stronger in stocks without traded options than in stocks with options listed. Insider trades prior to unscheduled announcement are more profitable than those before scheduled ones.Research limitations/implicationsThe paper examines whether there is a difference between the effects of optioned stock and non-optioned stock. Roll et al. (2010) use the relative trading volume of options to stock ratio (O/S) to proxy for informed options trading activity. Future research could explore the impact of O/S. Moreover, the authors examine how insiders with private information use such information to trade in their own firms. Mehta et al. (2017) argue that insiders also use private information to facilitate trading (shadow trading) in linked firms, such as supply chain partners or competitors. Therefore, future research could consider the impact of shadow trading.Social implicationsSince the insider’s propensity to buy before announcements in stocks without options listed is larger than in stocks with traded options and the relationship is stronger for unscheduled announcements than for scheduled ones, the efforts of regulators should focus on monitoring insider trading in stocks without options listed prior to unscheduled announcements.Originality/valueFirst, Lei and Wang (2014) find that the increasing pattern of insider’s propensity to trade before unscheduled announcements is larger than that before scheduled announcements. The authors document the underlying option has impacted the insider’s propensity to purchase and sell, and the relationship is stronger for unscheduled announcements than for scheduled ones. Second, related studies show insider’s trading activity has shifted from periods before corporate announcements to periods after corporate announcements to decrease litigation risk. This paper find the underlying option has influenced the proportion of insiders’ trading after announcements relative to before announcements when the illegal insider trade-related penalties increase.

Analysis on the Effect of Price Discovery in Mini Derivatives : The Case of KOSPI200 Mini Options

The KOSPI200 mini options market, introduced in July 2015, is a market where the trading multiplier is reduced to one-fifth of the regular options. This study shows that the price discovery effect of the original options and the mini options estimated by the vector error correction model (VECM) and Hasbrouck's information share (1995, 2003), based on the regular options-mini options arbitrage and the options-spot arbitrage. The results of the empirical analysis are summarized as follows. First, in the price discovery between the regular options and the mini options, regular options dominate mini options at a statistically significant level. Second, mini options tend to lead the spot, which is stronger than the regular options. Therefore, the regular options and the mini options show asymmetrical behavior in the price discovery process of the spot, opposite to each other and are interpreted as alternative derivatives in terms of investment strategy. Considering the immaturity of mini options market established during the sample period, the price discovery is efficient even though the trading activity in the mini options is lower than that of the regular options.