Informed Option Trading around Merger Announcements
50 Pages Posted: 12 Jul 2008
Date Written: July 12, 2008
This paper examines option trading prior to significant information events. Using a broad sample of merger announcements, I find that there is abnormal option trading prior to such announcements after controlling for merger characteristics. This abnormal option trading is mainly concentrated in short-term and at-the-money options. Trading volume in these options leads stock market order imbalances and strongly contributes to the pre-takeover stock price runup. Implied volatility spread calculated from these options is strongly positively associated with the abnormal option volume. Finally, I also investigate whether option trading volume can be used to predict takeover targets. I find strong predictive power of option volume for takeover targets.
Keywords: Informed Trading, Options Market, Merger Announcements
JEL Classification: G10, G12, G14
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