Why Large Financial Institutions Buy Put Options from Companies

32 Pages Posted: 11 Apr 2001

See all articles by Vladimir A. Atanasov

Vladimir A. Atanasov

William and Mary - Raymond A. Mason School of Business

Stanley B. Gyoshev

XFI Centre for Finance and Investment - University of Exeter Business School

Samuel H. Szewczyk

Drexel University - Department of Finance

George P. Tsetsekos

Drexel University - Department of Finance

Date Written: July 31, 2004

Abstract

This study explores the strategic interaction between large institutional investors and firms that issue put options written on their own stock. The firms experience large positive abnormal annual returns after they sell put options. The vast majority of issued put options expire without being exercised, and the buyers of these options, which are predominantly investment banks, lose money. We propose a model that gives a rationale why an uninformed party, an investment bank will trade in put options with an informed party, the issuing firm, although the expected profits from this trade are negative. The model shows how trading with an informed party can be profitable because the bank can acquire valuable information and afterwards earn abnormal returns on trades in other securities of the same firm. Finally, we outline several predictions from the model, and propose empirical tests to establish our proposition that an investment bank can legally acquire private information and trade profitably on it.

Keywords: Investment banks, put option, screening model

JEL Classification: G24

Suggested Citation

Atanasov, Vladimir A. and Gyoshev, Stanley B. and Szewczyk, Samuel H. and Tsetsekos, George P., Why Large Financial Institutions Buy Put Options from Companies (July 31, 2004). Available at SSRN: https://ssrn.com/abstract=266544 or http://dx.doi.org/10.2139/ssrn.266544

Vladimir A. Atanasov (Contact Author)

William and Mary - Raymond A. Mason School of Business ( email )

P.O. Box 8795
Williamsburg, VA 23187-8795
United States

Stanley B. Gyoshev

XFI Centre for Finance and Investment - University of Exeter Business School ( email )

University of Exeter
Xfi Building, Rennes Dr.
Exeter, EX4 3BZ
United Kingdom
+44-1392-72-3227 (Phone)
+44-1392-262475 (Fax)

HOME PAGE: http://business-school.exeter.ac.uk/about/whoswho/index.php?web_id=Stanley_Gyoshev&tab=profile

Samuel H. Szewczyk

Drexel University - Department of Finance ( email )

LeBow College of Business
Philadelphia, PA 19104
United States
215-895-1746 (Phone)

George P. Tsetsekos

Drexel University - Department of Finance ( email )

College of Business
Philadelphia, PA 19104
United States
215-895-1741 (Phone)
215-895-2955 (Fax)

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