Speculation or Insider Trading: Informed Trading in Options Markets Preceding Tender Offer Announcements

Abstract

In our sample of 305 cash tender offers occurring between 1993 and 1998, we find evidence that the options market has become the preferred trading venue for informed traders. Given this result, we analyze individual call option contracts for those tender offer targets with traded options, identifying the one optimal insider contract which maximizes the returns to insiders with perfect knowledge of a pending tender offer. This analysis allows us to test the competing market anticipation and insider trading theories of pre-bid stock price and volume run-ups using the trading patterns of options which should be preferred by insiders and those preferred by speculators. Our individual contract analysis is consistent with both theories as we find trading in both insider-preferred and speculator-preferred contracts drives aggregate call option volume run-ups. However, heavy trading in the optimal insider contract occurs on heavy volume days for all contracts. These results support the notion of Easley, O'Hara, and Srinivas (1998) that a substitution effect exists whereby informed traders prefer to trade in options markets when possible and that insiders will hide their trades within those of speculators.

Keywords: Informed trading, insider trading, options, tender offer

JEL Classification: G10, G14, G34, K22, K42