Title

Informed trading around information announcements

Date of Award

12-2000

Degree Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Department

Finance

Advisor(s)

Thomas J. Finucane

Keywords

Informed trading, Information announcements, Options markets, Signed option trade volumes

Subject Categories

Finance

Abstract

Black (1975) posited that informed traders would utilize the options market given that market's greater leverage and lower transaction costs. If informed traders do gravitate to the options market, it is possible that information may be reflected in the options market prior to the stock market. This has led subsequent researchers to investigate the lead/lag relationship between these two markets.

A recent paper by Easley, O'Hara and Srinivas (1998) suggested that signed option trade volumes (i.e. positive news volumes consist of buying calls or selling puts and negative news volumes consist of selling calls or buying puts) would be informative about future equity prices. The results of their study demonstrated that ordinary option volumes contained no information about future equity prices; signed option trade volumes did contain information about future stock prices. However, positive news volumes preceded stock price decreases while negative news volumes preceded stock price increases.

The present study extends the work of Easley, O'Hara and Srinivas by focusing on option trades which are executed around information events (i.e. quarterly earnings releases and unanticipated information events). Previous research (e.g., Kim and Verrecchia (1994)) has suggested that informed traders prefer to transact around information events. Two perspectives are employed. The first utilizes the Vector Auto Regression approach of Hasbrouck (1991) to determine if signed option trade volumes are viewed as informative by the equity market maker. The second analyzes signed option trades on an ex-post basis to determine whether the trades executed prior to information events were in fact informed.

The results of this study demonstrate that signed option trade volumes per se are not informative about future equity prices around information events. The unexpected components of signed option trade volumes (i.e. relative and absolute trade informativeness) were found to be informative about equity quote revisions; however, there was no incremental informativeness associated with these innovations around information events. The ex-post analysis indicated that signed option trades executed prior to earnings releases were consistent with informed trading; the results were particularly strong for small capitalization companies and out-of-the-money option transactions.

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