Information or Speculation: What Motivates Pre-Earnings Announcement Option Activity?

Abstract:     
Following prior studies that suggest that option volume contains information about underlying stock prices, we examine option activity prior to earnings announcements. Results in this study show that put (call) volume relative to total option volume is higher prior to unfavorable (favorable) announcements. However, we find that the ability of put (call) ratios to predict negative (positive) future returns weakens during the pre-announcement period, thus questioning the level of informativeness of pre-announcement option activity. Interestingly, pre-announcement put ratios are driven by stocks with low last-quarter skewness, while pre-announcement call ratios are driven by stocks with high last-quarter skewness. While prior studies argue that pre-announcement option activity contains private information, our findings indicate that pre-announcement option trading is also motivated by speculation which may adversely affect the level of informed trading in the options market.

Number of Pages in PDF File: 32

Keywords: Informed Trading, Speculation, Options

JEL Classification: G10, G14

working papers series