The nature of informed option trading

Inhaltsverzeichnis (Table of Contents)

• Introduction
• Literature Review
  • The value of mergers and acquisitions
    • Occurrence and characteristics
    • Event studies on the wealth effects of acquisitions
      • Abnormal returns methodology
      • Takeover premiums
      • Bidding firms' announcement returns
    • Disentangling synergistic gains and other informational effects
      • Information asymmetry and the method of payment
      • Revelation, truncation, and information timing
  • Cross-section of options and stocks: Evidence from M&A transactions
    • Price discovery process in the options and stock market
      • Definitions
      • The role of informed traders
      • The predictive power of option implied volatilities
    • Event studies: predicting announcement returns with option trading proxies
      • Trading activity around corporate announcements (earnings)
      • Predictability of M&A announcement returns
    • Conceptual framework and hypothesis development
  • Data and methodology
    • Data
    • Methodology and Summary Statistics
      • Cumulative abnormal returns
      • Primary explanatory variables
      • Hypothesis testing
        • Pre-announcement liquidity
        • Cross-sectional regression and control variables
        • Effect of deal characteristics on CAR predictability
  • Empirical results
    • Option liquidity
    • Predictive power of options for CARS
      • Sorted portfolio approach
      • Regression results
      • Deal and target characteristics
      • Significance of the results
  • Conclusion

  Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)

  This thesis investigates the type of information that "informed" traders possess before a takeover announcement, utilizing options on target firms. The primary objective is to determine whether option liquidity changes before a takeover announcement, suggesting the presence of informed traders. The research further examines the predictive power of various informed option trading proxies for target announcement returns and explores how deal characteristics might influence this relationship. The key themes of the research are:
  • Informed Trading in Options Markets
  • Predictive Power of Option Trading Proxies for Takeover Announcement Returns
  • The Role of Deal Characteristics in Informed Trading
  • The Price Discovery Process in the Options and Stock Markets
  • The Value of Mergers and Acquisitions

  Zusammenfassung der Kapitel (Chapter Summaries)

  • Introduction: This chapter introduces the topic of informed trading in the context of mergers and acquisitions (M&A), highlighting the importance of understanding the information possessed by informed traders. It presents the research question of this thesis: what information do informed option traders possess regarding the target firm and the deal before the takeover announcement?
  • Literature Review: This chapter reviews existing literature on the value of mergers and acquisitions, the wealth effects of acquisitions, and the relationship between stock and options markets. It examines previous studies on the predictive power of option trading proxies for announcement returns, particularly focusing on the role of informed traders and their knowledge about the takeover. It explores how information asymmetry and deal characteristics affect the price discovery process.
  • Data and Methodology: This chapter outlines the data sources and methodologies employed in the research. It describes the data collection process for M&A events, options, stocks, and company information. The chapter explains the methodology used to calculate cumulative abnormal returns (CARs) and the key explanatory variables, as well as the hypothesis testing procedures.
  • Empirical Results: This chapter presents the empirical findings of the study. It analyzes option liquidity before takeover announcements, examining the predictive power of option liquidity proxies. The chapter further investigates the relationship between informed option trading proxies and takeover announcement returns, exploring the influence of deal characteristics.

  Schlüsselwörter (Keywords)

  This thesis examines informed trading in options markets, particularly in the context of mergers and acquisitions. It explores the predictive power of various option trading proxies, including implied volatility, implied volatility skew, and relative option-to-stock trading volume, for takeover announcement returns. The research also investigates the role of deal characteristics, such as managerial entrenchment and the method of payment, in influencing informed trading activity and the price discovery process. Key concepts include information asymmetry, liquidity, and the relationship between stock and options markets.

  Frequently Asked Questions

  What is "informed trading" in the context of takeovers?

  It refers to trading activity by individuals who possess private, non-public information about a future merger or acquisition before it is officially announced.

  How can option liquidity predict a takeover?

  An increase in option liquidity before an announcement often indicates that informed traders are entering the market to leverage their private knowledge.

  What are IV skew and O/S volume?

  IV skew (implied volatility skew) and the relative option-to-stock (O/S) trading volume are proxies used to identify informed trading patterns in the options market.

  Does target management entrenchment affect informed trading?

  Yes, the research suggests that the predictive power of trading proxies increases when target management is entrenched, potentially due to higher information asymmetry.

  What is the "IV spread"?

  The IV spread is the difference between the implied volatilities of call and put options. Interestingly, this study found it had no significant predictive power for takeover returns.