Why Do Investment Banks Buy Put Options from Companies?

Abstract

Companies collected billions in premiums from peculiarly structured put options written on their own stock, while almost all of these puts expired worthless quarter after quarter. Buyers of these options, primarily investment banks, lost money as a result. Although these losses might seem puzzling, we model how by offering to buy put options from better informed parties, investment banks receive private information about the issuing company. Empirically, we find a 12% increase in the stock prices and a 40% increase in the trading volumes around the put sales, indicating indeed that investment banks, the bankers personally or their clients may have acted on information obtained from these transactions.

Keywords: Screening, Separating Equilibrium, Put Options, Information Acquisition, Strategic Trading

JEL Classification: G12, G14, G24, G28, C7, D82