Informational content of options trading on equity returns and corporate events

Abstract

This dissertation consists of three empirical studies about the informational content of options trading on subsequent equity returns and around major corporate events, such as mergers and acquisitions, and bankruptcies.

The first chapter examines the informational content of options trading on acquirer announcement returns. I show that implied volatility spread predicts positively on the cumulative abnormal return (CAR), and implied volatility skew predicts negatively on the CAR. The predictability is much stronger around actual merger and acquisition (M&A) announcement days, compared with pseudo-event days. The prediction is weaker if pre-M&A stock price has incorporated part of the information, but stronger if acquirer’s options trading is more liquid. Finally, I find that higher relative trading volume of options to stock predicts higher absolute CARs. The relation also exists among the target firms.

In the second chapter, I reassess the presence of pre- bankruptcy-filing informed and insider trades by examining the information content of options trading before bankruptcy announcements. I find that bankruptcy filing returns are not significantly related to pre-filing insider stock trading. However, filing returns are significantly negatively related to pre-filing insider and informed options trading. The informational content of options trading reduces with options illiquidity and the amount of information impounded into pre-filing stock prices.

In the third chapter, I use data on signed option volume to study which components of option volume predict returns and resolve the apparent inconsistency in the literature. I find no evidence that trades related to synthetic short positions in the underlying stocks contain more information than trades related to synthetic long positions. Purchases of calls that open new positions are the strongest predictor of returns, followed by call sales that close out existing purchased call positions. The signed O/S measures also predict announcement returns for both earnings announcements and unscheduled corporate events. Overall the results indicate that the role of options in providing embedded leverage is the most important channel why options trading predict stock returns.