How Common is Insider Trading? Evidence from the Options Market
36 Pages Posted: 21 Jul 2022 Last revised: 26 Jul 2022
Date Written: June 30, 2022
Option traders are considered among the most informed investors because their trades strongly predict future stock returns. We identify the source of their information edge using a quasi-exogenous shock to insider trading enforcement. With the arrest of Raj Rajaratnam, prosecutors launched an unprecedented campaign against insider trading making such trading much riskier. Before the arrest, the put-call ratio that aggregates information content of option trades earned a 0.24% weekly alpha among S&P 500 stocks. But this striking predictability suddenly disappeared shortly after Raj’s arrest, as option investors refrained from trading on insider information. These results suggest that insider trading used to be prevalent in the options market and explain why option trades used to predict stock returns.
Keywords: Insider trading, informed trading, equity options, return predictability
JEL Classification: G10, G14
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