Informed Options Trading prior to M&A Announcements - NYU Stern

79 Pages·2016·2.27 MB·English

MANAGEMENT SCIENCE
ArticlesinAdvance,pp.1–24
http://pubsonline.informs.org/journal/mnsc/ ISSN0025-1909(print),ISSN1526-5501(online)
Informed Options Trading Prior to Takeover Announcements:
Q:1,2
Insider Trading?
Q:3 PatrickAugustin,aMenachemBrenner,bMartiG.Subrahmanyamb
aDesautelsFacultyofManagement,McGillUniversity,Montreal,QuebecH3A1G5,Canada;bLeonardN.SternSchoolofBusiness,
NewYorkUniversity,NewYork,NewYork10012
Contact:[email protected], http://orcid.org/0000-0001-9138-4860(PA);[email protected](MB);
[email protected](MGS)
Received:December3,2015 Abstract. Wequantifythepervasivenessofinformedtradingactivityintargetcompanies’
Revised:August26,2016;December15,2017 equityoptionsbeforetheannouncementsof1,859U.S.takeoversbetween1996and2012.
Accepted:April8,2018 About25%ofalltakeovershavepositiveabnormalvolumes,whicharegreaterforshort-
PublishedOnlineinArticlesinAdvance: dated, out-of-the-money calls, consistent with bullish directional trading before the an-
∎∎∎∎,2018 nouncement.Overhalfofthisabnormalactivityisunlikelyduetospeculation,newsand
rumors,tradingbycorporateinsiders,leakageinthestockmarket,dealpredictability,or
https://doi.org/10.1287/mnsc.2018.3122
beneficial ownership filings by activist investors. We also examine the characteristics of
Copyright:©2018INFORMS optiontradeslitigatedbytheSecuritiesandExchangeCommission(SEC)forallegedillegal
insidertrading.Althoughthecharacteristicsofsuchtradescloselyresemblethepatternsof
abnormaloptionvolumeintheU.S.takeoversample,wefindthattheSEClitigatesonly
about8% ofall deals in it.
History:AcceptedbyLaurenCohen,finance.
Q:4 Funding:ThisprojectwassupportedbytheSocialSciences&HumanitiesResearchCouncilofCanada
[SSHRC430-2014-00747]andtheChicagoMercantileExchange.P.Augustinacknowledgesfinancial
supportfromtheInstituteofFinancialMathematicsofMontreal.
SupplementalMaterial:Theonlineappendixisavailableathttps://doi.org/10.1287/mnsc.2018.3122.
Keywords: civillitigations (cid:129)derivatives (cid:129)insidertrading (cid:129)mergersandacquisitions
Q:5
Q:6 1. Introduction plausibly explain the abnormal trading volumes in
Q:7 How pervasive is informed options trading around options based on correct anticipation of upcoming
takeover announcements? Cao et al. (2005), for ex- takeoveractivity.Itisthedeal-by-dealexaminationof
ample, suggest that abnormal trading in equity op- the preannouncement activity that allows us to ex-
tionspriortotakeoverannouncementsisinformed,as amine the overlaps in explanations across deals and
directional trading activity positively foreshadows to identify the deals with abnormal options activity
futurepricemovements.1Thisfindingraisesquestions that are unlikely to be anticipated. Third, we also
about the nature of the run-up in option volumes verifywhethertherun-upmaybetheresultofillegal
before takeover announcements and the distribution insider trades reported by the Securities and Ex-
ofinformedtradingacrossdeals.Istherun-updriven change Commission (SEC), and we compare the
byafewdealswithsignificantvolumes,ordoalldeals characteristics of all option trades litigated for alleged
contribute to the options activity that is abnormal on illegalinsidertradingwiththoseofthepreannouncement
average?Whatinformationdrivestheindividualrun- options activity. This comparison strengthens our as-
ups in option volumes, and can they be explained by sessment of the nature and sources of the preannounce-
publicly available sources of information besides il- ment run-up in option volumes.
legal insider trading? In this paper, we characterize Wedocumentthatabout25%(467)ofalldealsinour
the pervasiveness of informed options trading around sample have abnormalvolumes of equityoptions over
takeover announcements and study the sources of the 30-day period preceding the takeovers, which are
the preannouncement run-up in option volumes. statisticallysignificantatthe5%level.Theproportionof
We first quantify the pervasiveness of informed caseswithabnormalvolumesisrelativelyhigherforcall
tradingintheequityoptionsoftargetcompaniesahead options than for put options. Stratifying the results by
of 1,859 U.S. takeover transactions between January “moneyness,” we find that there is significantlyhigher
1996 and December 2012. To better understand the abnormal trading volume in out-of-the-money (OTM)
sources of informed trading, in the second step, we calloptionscomparedwithat-the-money(ATM)andin-
examine a large number of channels that could the-money (ITM) calls.2
1
Augustin,Brenner,andSubrahmanyam:OptionsTradingBeforeTakeoverAnnouncements
2 ManagementScience,ArticlesinAdvance,pp.1–24,©2018INFORMS
An examination of the characteristics of cumulative whereas about 44% of all deals exhibit excess implied
abnormalvolumeshowsthatinformedtradingismore volatility. Although 19% of the takeover transactions
pervasive for larger deals, those for which informed exhibitstatisticallysignificantabnormalstockvolume—
investors may potentially have less uncertainty about a frequency somewhat lower than in the options
thefinaltakeoverprice,andincaseswheretargetfirms market—the economic magnitude is substantially
receive cash offers. We study the trading volume, smaller.Thus,quantifyinghowmanydealsaresubject
implied volatility, and bid-ask spreads of equity op- to informed trading may also be informative about
Q:8 tions, and we consider a number of robustness tests, whether informed trading is more prevalent in the
which support the evidence of informed investors options or in the stock market.
tradingdirectionallyin anticipation ofa price jump in Next,weshowthatitisdifficulttopredicttakeover
the target company’s stock. It is the deal-by-deal ex- announcements based on publicly available informa-
amination of the preannouncement activity that helps tion. Thus, the documented abnormal option trading
usappreciatethepervasivenessofinformedtradingin volume is unlikely due to traders’ ability to time the
takeover transactions. market. However, we observe that most of the in-
We next explore whether the takeover announce- formed activity arises in the 5–10 days before the in-
ments could have been anticipated based on public formationgetspubliclyreleased.Finally,wescreenthe
sourcesofinformation.Wefirstshowthattherun-upin Schedule13Dbeneficialownershipreports,whichneedQ:9
optionsvolumeisunlikelyduetospeculativetrading tobefiledbyregisteredactiveinvestmentadvisorsno
activity in response to observable stock trading ac- laterthan10daysfollowingtheacquisitionofbeneficial
tivity or industry and firm characteristics. We com- ownership of more than 5% of any class of publicly
pare the options activity in the takeover sample to traded securities. The trading we identify by suppos-
severalcontrolsamplesthatarematchedeitheronthe edly informed activist investors is unlikely to fully
stock market activity or on industry and firm char- explain the abnormal options activity, as only 17 of
acteristics.Informedtradingactivityinoptionsahead these deals have a filing in the 30-day period prior to
of takeover announcements is absent from these con- the takeover announcement date.
trol groups. Of the 467 deals in our sample with significant cu-
Inaddition,weexaminehowmuchoftheinformed mulative abnormal options volume, 13% (236) are
optionsactivitycanbeexplainedbynewsandrumors. unlikely to be associated with publicly available
To identify rumors and news about upcoming take- sources of information. In the subsample of 236 deals,
overs, we use RavenPack News Analytics, a database we exclude those deals that exhibit statistically sig-
that is constructed from textual information in major nificant stock volume or returns, which appear to lag
newspaper outlets, public relations feeds, and more the option market in the takeover preannouncement
than19,000othertraditionalandsocialmediawebsites. period.Anadditionalchannelthatmaydrivetherun-
Weassociatenewswith170takeovertransactionsand up in options volume could be illegal insider trading.
with only 9% (40/467) of the deals that exhibit in- Therefore, we filter through more than 8,000 public
formed options activity. We find no statistically sig- SEClitigationrecordsdatedbetween1990and2013to
nificantdifferenceintheaveragecumulativeabnormal identify whether the takeover transactions in our
options trading volumes between the sample of 170 sample were subject to a litigation for alleged insider
takeovers with news and the sample of 1,689 without trading.WefindthattheSEClitigatedabout8%ofthe
news. We further check whether the option trades takeovers in our sample for insider trading in options
originate from corporate insider accounts. Corporate orstocksandonly9%(43/467)ofthetransactionsthat
officers, directors, or large block-holders are legally we associate with informed trading. Moreover, only
required to disclose security transactions in their 10%(24/236)ofthedealsthatwefailtoassociatewith
company’s options. An analysis of the derivative public sources of information are involved in a litiga-
transactionsandholdingsinformationintheThomson tion. Thus, the number of civil lawsuits for insider
Reutersinsiderfilingsrevealsthatnotasingleoptions trading appears modest in comparison with the per-
transaction was executed by registered insiders in the vasiveinformedtradingactivityreflectedin25%ofthe
30-day period before the announcement. takeover transactions.
We also consider the possibility that astute option Using the SEC’s litigation records, we hand-collect
traders trade on information leakage in the stock information on the size, timing, and type of illegal
market. However, our analysis suggests that option trades;wesupplementwithinformationinthecriminal
volumeleadsstockvolume,andthatpaststockvolume recordsfromtheU.S.DepartmentofJustice(DoJ).TheQ:10
and return performance is not significantly related to characteristics of the illegal option trades—that is,
future abnormal options activity. In addition, we find short-dated OTM call options on target companies
that only 7% of the deals in our sample exhibit ab- that are initiated, on average, 21 days before the
normal stock returns in the preannouncement period, announcement—closely resemble the characteristics
Augustin,Brenner,andSubrahmanyam:OptionsTradingBeforeTakeoverAnnouncements
ManagementScience,ArticlesinAdvance,pp.1–24,©2018INFORMS 3
and timing of the abnormal options activity in a rep- abnormaloptionsvolumeisgreaterforcallthanforput
resentative sample of takeover transactions. This options.Usingsignedvolume,Caoetal.(2005)support
resemblance,coupledwiththeabsenceofpublicinforma- the presence of informed activity because prior to
tion sources that could have led to the anticipation of takeover announcements, the option volume order
the takeover transaction, calls for further regulatory imbalancecontainsinformationregardingsubsequent
examination of the informed options activity. stock price movements, greater call volume balances
DeMarzoetal.(1998)suggestthatitmaybeoptimal are associated with greater announcement returns,
to prosecute insiders only after large price moves or andtheoptionsmarketdisplacesthestockmarketfor
afterlargevolumetransactions.WefindthattheSECis information-based trading (see also Arnold et al.
likely to examine large target firms that experience 2006). Acharya and Johnson (2010) show that a large
substantial abnormal returns after the takeover an- number of equity participants in leveraged buyout
nouncement and in which the acquirers are head- syndicates is associated with greater levels of suspi-
quarteredoutsidetheUnitedStates.Wefind,however, cious stock and options activity. Clements and Singh
no evidence that the probability of litigation is posi- (2011) argue that preannouncement options volume
tively related to the preannouncement abnormal op- reflects both informed and “contraire” trading, and
tions volume. Shafer (2012) documents a positive correlation be-
Weextendtheliteraturealongthreekeydimensions. tween the preannouncement option-to-stock volume
Q:11 First, in this paper, we quantify the prevalence of in- ratio and the probability of being a takeover target
formed trading and document that the informed op- that becomes weaker after Regulation Fair Disclosure
tionsactivityisdrivenby25%ofalldeals,incontrastto in 2000.
priorresearch.Second,wedivergefrompreviouswork Many studies have corroborated the evidence of
and examine the sources of informed trading in the abnormal preannouncement option activity in target
options market and show that for at least 13% of all companies in the United States and United Kingdom
deals, it is difficult to associate the abnormal options (Spyrouetal.2011).Theliteratureemphasizesdifferent
activity with public sources of information. Third, aspects of the preannouncement activity, including
a unique feature of our research is that we study the abnormal changes in the implied volatility (IV) skew,Q:12
characteristics of SEC-litigated cases related to insider IV spread, and the option-to-stock volume ratio
trading in options prior to takeover announcements. (Klapper 2013); a positive correlation between pre-
This allows us to compare the nature of abnormal announcement run-up and abnormal options volume
options activity to illegal option trades and examine (Wang 2013); an increasing importance of options’
how the SEC’s litigation record relates to abnormal leading role for price discovery (Liu et al. 2015); or
options trading around takeover announcements. a greater propensity of informed trading to occur in
moreliquidandhigherleverageoptions(Podolskietal.
2. Literature Review 2013). Chan et al. (2015) show that the one-day pre-
The run-up in the stock prices of target companies event implied volatility spread (the implied volatility
before merger andacquisition (M&A)announcements skew), a proxy for informed option trading, is posi-
is well documented (Mandelker 1974, Dodd 1980, tively(negatively)associatedwithacquirercumulative
Asquith 1983, Jensen and Ruback 1983, Dennis and abnormal returns. Ordu and Schweizer (2015) associ-
McConnell 1986, Schwert 1996). A long-standing de- ate greater abnormal volumes with greater chief ex-Q:13
bate relates to whether this run-up is due to public ecutive officer wealth-to-performance sensitivity for
information such as, for example, media speculation stock-financedtakeovers, suggesting that informedman-
(JarrellandPoulsen1989),orwhetheritistheresultof agers hedge anticipated negative acquirer announce-
privateinformationleakageandillegalinsidertrading ment returns. Focusing also on acquirers, Huang and
(KeownandPinkerton1981,Meulbroek1992,Sanders Tung (2016) find a positive relation between an-
and Zdanowicz 1992). nouncement returns and preannouncement option-
Abnormal options volume and price activity ahead to-stock volume ratios,which are positively related to
ofM&Aannouncementshavebeenthesubjectofmany idiosyncratic stock volatility. Chesney et al. (2015)
papers, particularly in recent years. Jayaraman et al. propose a method for detecting abnormal options ac-
(1991) are the first to document a preannouncement tivity and relate six unusual transactions to M&A
increase in the option-implied volatilities of target announcements. Kedia and Zhou (2014) conclude in
companiesthatprecedeanincreaseinstockreturns,as favor of preannouncement informed trading in target
confirmedbyLevyandYoder(1993).Jayaramanetal. bonds. Poteshman (2006) concludes that informed in-
(2001) document that the abnormal options volume is vestors traded put options ahead of the 9/11 terrorist
accompanied by abnormal open interest that is con- attacks.
centrated in short-term OTM options, that it leads In Table 1, we show the differences between this
abnormal stock volume, and that the increase in studyandpriorwork.ApartfromSpyrouetal.(2011),
Augustin,Brenner,andSubrahmanyam:OptionsTradingBeforeTakeoverAnnouncements
4 ManagementScience,ArticlesinAdvance,pp.1–24,©2018INFORMS
Table1.InformedTradingAheadofTakeoverAnnouncements ’AuthorsandyearPapersfocusDatacharacteristicsSourcesofinformedtradingontargets fi...SECCountryStocksOptionsQuanticationTargetAcquirerNo.ofWithTimeRumors/SpeculationRegisteredStockPredictability/ActivistM&Alitigationtargetcharacteristicsoptionsperiodnewsinsidersmarketanticipationinvestorsadvisors...dealsleakage+3–33272719751984Jayaramanetal.UnitedStates(1991)3333–LevyandYoderUnitedStates212119821985(1993)+∗3333–3Jayaramanetal.UnitedStates333319861996(2001)333–Caoetal.(2005)UnitedStates.787819861994333–Arnoldetal.(2006)UnitedStates4014519942000333–AcharyaandJohnsonUnitedStates2128420002006(2010)33333–Spyrouetal.(2011)UnitedKingdom3,8751,81219872006333–3ClementsandSinghUnitedStates3935920012006(2011)333–3Shafer(2012)UnitedStates8248241996201033–3Klapper(2013)UnitedStates2,3902,39019962012333–33Wang(2013)UnitedStates3,1243,1241996200833–3Podolskietal.(2013)UnitedStates81581519962008∗∗–335,98619962008OrduandSchweizerUnitedStates5,986(2015)333–3Liuetal.(2015)UnitedStates3,7111,57619962011333–Chanetal.(2015)UnitedStates2,3722,37219962010333–HuangandTungUnitedStates29129119962013(2016)333–3Lowryetal.(2017)UnitedStates703703200020113333–33333333Presentstudy(2018)UnitedStates1,8591,85919962012 ’“”Notes.Inthistable,wesummarizetheliteraturestudyinginformedoptionsactivityinthepreannouncementperiodofmergersandtakeovers,focusingontargetoptions.Wedescribeeachpapersgeographicalfocus(Country);whetheritexamineseitherfifi“fi”+)indicatesthattheauthorsdonotprovidestatisticalsignicancestockoroptionsactivity,orboth;whetheritexaminesbothtargetandacquireroptions;andwhetheritquantiesthepervasivenessofinformedoptionstrading(Quantication).Aplussign(“”’forcaseswithincreasedoptionsactivity.Forthedatacharacteristics,wereportthenumberoftargetdeals(wheretheasterisk*referstoacquirerdeals),thesubsampleofdealswithoptiondataavailability,andthestudystimeperiod.Weindicatethesourcesofinformedtradingactivitystudiedforabnormalactivityintargetoptions:rumors/news,speculation,optionstradingbyregisteredinsiders,stockmarketleakage,mergerpredictability,tradingbyactivistinvestors,andtradingbyconnectedM&Aadvisorydesks.WealsoindicatewhetherthestudyexaminestheoccurrenceofillegalinsidertradinglitigationsinitiatedbytheSECandwhetherthestudydescribesthenatureandcharacteristicsofoptiontradesprosecutedbytheSEC.
5
4
Q:
Augustin,Brenner,andSubrahmanyam:OptionsTradingBeforeTakeoverAnnouncements
ManagementScience,ArticlesinAdvance,pp.1–24,©2018INFORMS 5
who examine UK data, most studies are not informa- takeover of Carnation by Nestlé. Both studies find
tiveaboutthedistributionofinformedoptionstrading. positivepriceimpactsandeitherapositiveornoeffecton
Forasmallsamplethatisnotrepresentativeofoption bid-ask spreads or depth. Fishe and Robe (2004) find
trading over the last two decades, Jayaraman et al. that trading by brokers, who illegally had advance
(1991, 2001) identify positive changes in implied vol- access to news information on 116 stocks, negatively
atilities,withoutmentioningstatisticalsignificance.By impactedmarketdepth.Guercioetal.(2017)arguethat
contrast, we examine deals, case by case, and em- illegal insider trading has decreased in response to
phasize how and where insiders trade in the options moreaggressiveregulatoryenforcement.Ahern(2017)
market:theyengageindirectionalstrategiesfortargets, describes insider trading networks from civil and
which are reflected in more pronounced abnormal criminalprosecutionsinitiatedbytheSECandtheDoJ,
activity in OTM calls and cash-financed takeovers. In and Kacperczyk and Pagnotta(2016) show that market
addition, we consider synthetic option strategies that priceandliquiditysignalsareimpactedbyillegaltrading
lead to long bullish or short bearish exposures for using SEC litigation information. Heitzman and Klasa
targets,andwereviewearlierevidence,asthefindings (2016) document that investors trade quickly in stocks
appear to be inconsistent across studies.3 upon new information from nonpublic merger negoti-
Importantly, there is only scarce information on the ations. Bhattacharya (2014) provides a comprehensive
sources of informed options trading for target firms. literature review of insider trading. For a discussion
Klapper (2013) and Wang (2013) examine media spec- on the legal aspects of insider trading, see, for ex-
ulation and rumors, but their results are inconsistent ample, Arshadi (1998) and Crimmins (2013).
witheachother.4Liuetal.(2015)providesomeevidence Our focus differs from the literature examining in-
against the leakage hypothesis but do not explain formed stock trading by corporate insiders. For ex-
whetherabnormaloptionsactivityforagivendealmight ample,Cohenetal.(2012)showthatonlyopportunistic
be the result of abnormal stock activity. Lowry et al. transactions, as opposed to routine transactions, have
(2016) indicate that trading desks connected to M&A predictivecontentforstockprices.AgrawalandNasser
advisorydeskstakeabnormalcalloptionpositionsinthe (2012)discusswidespread“passive”insidertradingon
target companies from seven quarters to one quarter targets, whereby registered insiders increase their net
before the announcement. Ordu and Schweizer (2015) exposurethroughreducedstockselling.Ourfocusison
examinethesourcesofinformedtrading(managers)but option trading, not stock trading.
focusontheoptionsoftheacquirers.Ourfocushereison Our work broadly relates to the literature on when
documentingtheabnormaloptionsactivityforthetarget andhowinformedagentschoosetotradeintheoptions
firmsandidentifyingthespecifictypesofoptionstraded market in the presence of asymmetric information
before the announcement. (Easleyetal.1998),differencesinopinion(CaoandOu-
Some authors examine the illegal insider trading in- Yang2009),short-saleconstraints(JohnsonandSo2012),
vestigated by the SEC (Jayaraman et al. 2001, Podolski or margin requirements and wealth constraints (John
etal.2013)orstudythepredictabilityofSEClitigations et al. 2003) and on the predictability of option-implied
(Wang2013).Usingaproprietarysampleofillegaltrades measures for stock returns (Easley et al. 1998, Pan and
litigated by the SEC, Meulbroek (1992) and Meulbroek Poteshman 2006, Cremers and Weinbaum, 2010, Xing
and Hart (1997) document that insider trades have an etal.2010,Jinetal.2012,JohnsonandSo2012,Hu2014,
immediate effect on stock prices, that half of the pre- Tse-Chun and Xiaolong 2015). Several other papers are
announcement run-up occurs on insider trading days, peripherallyrelatedtothispaper.Rolletal.(2010)study
and that the announcement returns are a third larger therelationbetweentheoption-to-stocktradingvolumeQ:14
wheninsidertradingisdetected.Frinoetal.(2013)study and postearnings announcement returns. Subramanian
hand-collectedSEClitigationsandfindthatillegalstock (2004)andBesteretal.(2011)developtheoreticaloption
trades are positively associated with subsequent price pricingmodelsforthetargetinthecaseofstock-for-stock
changes but negatively associated with the size of the and cash mergers, respectively.
penaltiesandthestock’sliquidity.However,wefindno
information in the literature on the characteristics and
3. Data Selection and Takeover
patterns of option trades litigated for illegal insider
trading,noronhowprosecutionrelatestothedegreeof Deal Characteristics
abnormal options activity. In this paper, we relate our The data for our study come from three primary
results to the literature associated with illegal insider sources: the Thomson Reuters Securities Data Com-
trading in stocks. panyPlatinum(SDC)database,theCenterforResearch
Cornell and Sirri (1992) and Chakravarty and in Securities Prices (CRSP) database, and the Option-
McConnell (1997, 1999) conduct clinical studies of Metrics database. We start our sample selection with
illegal stock trades ahead of the 1982 takeover of the full domestic M&A data set for U.S. target firms
Campbell Taggart by Anheuser-Busch and the 1984 from SDC Platinum for the time period from JanuaryQ:15
Augustin,Brenner,andSubrahmanyam:OptionsTradingBeforeTakeoverAnnouncements
6 ManagementScience,ArticlesinAdvance,pp.1–24,©2018INFORMS
1996,thestartingdateforavailableoptioninformation price and volume information on the target prior to,
in OptionMetrics, through December 2012. Our final and including, the announcement date, which results
sampleconsistsof1,859takeovertransactionsforwhich inthefinalfullsampleof1,859takeoverannouncements.
we were able to identify matching stock and option All matches between SDC and CRSP–OptionMetrics
informationforthetarget.Thesedealswereundertaken are manually checked for consistency based on the
by 1,279 unique acquirers on 1,669 unique targets.5 company name.
Starting from an initial sample of 185,419 trans- Panel A in Table 2 reports the basic deal character-
actions, we restrict the study to deals aimed at af- istics for the full sample. Pure cash offers make up
fectingachangeofcontrol,wheretheacquirerowned the largest fraction of the sample (48.6%), followed
less than 50% of the target’s stock before the trans- by hybrid financing offers (22.3%) and share offers
actionandwasseekingtoownmorethan50%afterit. (21.7%).Only82.9%ofalltransactionsarecompleted,
Hence, our sample includes only M&As of majority andmergerstendtobemostlywithinthesameindustry,
interest, excluding all deals that were acquisitions of with53.4%ofalldealsbeingundertakenwithacompany
remainingorpartialinterest(minoritystakepurchases), in the same industry based on the two-digit Standard
acquisitions of assets, recapitalizations, or buybacks/ IndustrialClassification(SIC)code.Wefindthat90.2%of
repurchases/self-tender and exchange offers. In addi- alldealsareconsideredtobefriendlyandonly3.4%are
tion,weexcludedealswithpendingorunknownstatus hostile,whereas11.6%ofalltransactionsarechallenged.
(i.e., we only include completed, tentative, or with- For only 6.5% of the sample do the contracts contain
drawndeals).Theserestrictionsreducethesamplesize a collar structure, 76.5% of all deals involve a termi-
to 34,350 deals. Next, we require information on the nationfee,andinonly3.5%ofthetransactionsdoesthe
dealvalueandeliminatedealswithatransactionvalue bidder already have a toehold in the target company.
belowUSD1million,whichreducesthesamplefurther Panel B shows that the average deal size is USD 3.8
to 19,064 transactions. Finally, we match the infor- billion,withcash-onlydealsbeing,onaverage,smaller
mation from SDC with price and volume information (USD2.2billion)thanstock-onlytransactions(USD5.4
in both the CRSP and OptionMetrics databases. We billion). The average one-day offer premium, defined
requireaminimumof90daysofvalidstockandoption as the excess of the offer price relative to the target’s
Table2. DescriptiveOverview ofTakeover Sample
Offerstructure Cashonly Hybrid Other Shares Unknown Total
PanelA:Dealinformation
Q:54 Description No. %oftot. No. %oftot. No. %oftot. No. %oftot. No. %oftot. No. %oftot.
No.ofdeals 903 48.6 415 22.3 80 4.3 403 21.7 58 3.1 1,859 100.0
Completeddeals 746 40.1 357 19.2 67 3.6 339 18.2 33 1.8 1,542 82.9
Friendlydeals 805 43.3 379 20.4 69 3.7 382 20.5 42 2.3 1,677 90.2
Hostiledeals 35 1.9 14 0.8 3 0.2 7 0.4 4 0.2 63 3.4
Same-industrydeals 379 42.0 280 67.5 39 48.8 268 66.5 27 46.6 993 53.4
Challengeddeals 111 6.0 55 3.0 7 0.4 32 1.7 11 0.6 216 11.6
Competingbidder 83 4.5 32 1.7 3 0.2 20 1.1 4 0.2 142 7.6
Collardeal 4 0.2 54 2.9 3 0.2 52 2.8 7 0.4 120 6.5
Terminationfee 698 37.5 352 18.9 51 2.7 292 15.7 29 1.6 1,422 76.5
Bidderhasatoehold 42 2.3 11 0.6 2 0.1 7 0.4 3 0.2 65 3.5
PanelB:Dealfinancials
Description Mean SD Mean SD Mean SD Mean SD Mean SD Mean SD
DVal(USDmil) 2,242.0 4,147.2 5,880.9 10,071.5 5,074.2 10,387.7 5,429.8 15,158.5 1,635.7 2,503.7 3,848.4 9,401.3
P1d(%) 33.6 31.7 28.5 27.5 25.1 40.5 28.3 39.5 33.3 29.6 31.0 33.1
P1w(%) 36.6 31.0 32.4 29.1 29.5 42.5 33.6 61.5 33.4 29.8 34.7 39.8
P4w(%) 41.1 35.6 35.0 32.4 31.2 46.1 36.7 45.3 38.0 33.6 38.3 37.7
Q:46 Notes. InpanelA,wedescribethedealcharacteristicsofthe1,859takeoversbetweenJanuary1996throughDecember31,2012.Wereportthe
numberofdeals(“No.”)andthecorrespondingsampleproportions(“%oftot.”).Inaddition,wereporthowmanyofthedealsareclassifiedas
completed;friendly;hostile;involvingatargetandacquirerinthesameindustry;challenged;orhavingacompetingbidder,acollarstructure,
aterminationfee,orabidderwithatoeholdinthetargetcompany.Allcharacteristicsarereportedfortheoverallsample(column“Total”),as
well as for different offer structures: cash-financed (“Cash only”), stock-financed (“Shares”), a combination of cash and stock financing
(“Hybrid”),otherfinancingstructures(“Other”),andunknown(“Unknown”).InpanelB,weillustratethefinancialstatisticsofthedeals.We
reportthetransactionvalue(“DVal”)inUSDmillionandtheofferpremium,definedastheratiooftheofferpricetothetarget’sclosingstock
price.ThetermsP1d,P1w,andP4wrefertothepremiumoneday,oneweek,andfourweeks,respectively,priortotheannouncementdate,in
percentageterms.
Augustin,Brenner,andSubrahmanyam:OptionsTradingBeforeTakeoverAnnouncements
ManagementScience,ArticlesinAdvance,pp.1–24,©2018INFORMS 7
closing stock price one day before the announcement options and (b) ITM put options to ATM and OTM put
date, is 31%. options, written on the target firms, are higher prior to
takeover announcements.
4. Informed Options Activity Prior To test H1 and H2, we examine the deal-by-deal
to Takeovers trading volume in equity options written on target
The first objective of our empirical analysis is to firms during the 30 days preceding takeover an-
nouncements.Inanutshell,wefindthatapproximately
quantify the prevalence of informed trading using
25% of all deals in our sample exhibit statistically
options volume. Investors with private information
significantabnormaloptionsactivity(atthe5%level)in
abouttheanticipatedannouncementreturntradeoff
theoptions’marketleverage(Black1975)againstthe thepreannouncement period.IntheUnitedKingdom,
Spyrou et al. (2011) also document abnormal pre-
greater stock market liquidity and perhaps a lower
announcement options volume for 25% of the deals.
probability of detection. In the presence of asym-
ThemagnitudeofabnormalvolumeisgreaterforOTM
metric information (Easley et al. 1998), wealth con-
calloptionsthanforATMandITMcallsinoursample,
straints(Johnetal.2003),short-saleconstraints(Johnson
confirming the results of Cao et al. (2005). Our results
andSo2012),ordisagreement(CaoandOu-Yang2009),
suggest that the odds of abnormal volumes being
some informed investors will migrate toward the
greater in a sample with randomized announcement
option market. A necessary condition for informed
dates are at most one in a million.
preannouncementactivityis,therefore,thedetectionof
Q:16 abnormal options volume, as stated in Hypothesis 1.
Hypothesis1(H1). Thereisevidenceofpositiveabnormal 4.1. Identifying Abnormal Trading Volumes
tradingvolumeintheequityoptionsoftargetfirmspriorto We test H1 by applying event study methodology to
takeover announcements. trading volumes. To compute the abnormal trading
volume,weuse,asaconservativebenchmark,amarket
Investors with inside information would pursue
model for volume (MMV model), which accounts for
directional trading strategies on the target firm’s
themarketvolumeinoptions(mediantradingvolume
stock, as it almost always goes up after a takeover an-
across all options in the OptionMetrics database), the
nouncement(Andradeetal.2001).Thus,inthepresence
ChicagoBoardofOptionsExchangeVolatilityIndex,as
of superior information, a trading strategy involving
wellasthecontemporaneousreturnoftheunderlying
the purchase of OTM call options should generate
stockandthemarket,proxiedbythereturnontheS&P
asignificantlyhigherabnormalreturn,asaconsequence
500Index.Inaddition,wecontrolforlaggedvaluesof
ofthehigherleverage(“morebangforthebuck”).Hence,
the dependent and all independent variables. The es-
we expect a larger increase in abnormal trading vol-
timation window starts 90 days before the announce-
ume for OTM calls relative to ATM and ITM calls.
mentdateandfinishes30daysbeforetheannouncement
Moreover, an informed investor, taking advantage of
date. As we are interested in the abnormal trading
hisprivilegedknowledgeofthefuturedirectionofthe
volume in anticipation of the event, we use a 30-day
target’s stock price, may also increase the trading
event window before the announcement date. To ac-
volume through the sale of ITM puts, as these will
count for the possibility of clustered event dates, we
become less valuable with the increase in the target’s
correct standard errors in aggregate tests for cross-
stock price upon announcement. An alternative, and
sectional dependence.
more cash-intensive, strategy would be to mimic the
In panel A of Table 3, we show that the average
strategy of buying OTM calls by buying ITM puts
cumulativeabnormaltradingvolumefortargetfirmsis
coupled with the underlying stock, financed by bor-
positiveandstatisticallysignificant.Themagnitudeof
rowing.Thus,anabnormallyhighvolumeinITMputs
the average cumulative abnormal volume over the 30
may result from either mimicking the purchase of
preeventdaysisestimatedtobe8,946contractsforcall
OTM calls or taking a synthetic long position in the
options. For put options on the target, the average
stock (buying a call and selling a put with the same
cumulativeabnormalvolumeisalsopositive,butover
strikeprice).Aninformedtradermaypossiblyengage
the 30 preevent days, it is much smaller, at 1,559 con-
in more complicated trading strategies to hide his
tracts, and not statistically significant. The evolution
intentions.Irrespectiveofwhichstrategyisemployed,
of the average abnormal and cumulative abnormal
weshouldobserveabnormaltradingvolumeinOTM
tradingvolumeforthetargetsisillustratedinFigure1.
call and/or ITM put options if investors with precise
It is apparent that the average cumulative abnormal
information exploit option leverage. This leads to
trading volume in put options is quantitatively less
a sharper prediction in Hypothesis 2.
important than that in call options, which primarily
Hypothesis 2 (H2). The ratios of the abnormal trading drives the results for the overall sample. The daily
volumes in (a) OTM call options to ATM and ITM call average abnormal volume for call options is positive
Augustin,Brenner,andSubrahmanyam:OptionsTradingBeforeTakeoverAnnouncements
8 ManagementScience,ArticlesinAdvance,pp.1–24,©2018INFORMS
Q:47 Table3. Positive Abnormal Options TradingVolume on TargetCompanies
PanelA:Magnitudeandfrequencyofcumulativeabnormalvolumedeals
Alloptions:Target OTMoptions:Target
Parameter All Calls Puts All Calls Puts
Sign.t-stat5%(no.) 446 467 304 423 408 451
Sign.t-stat5%(freq.) 0.24 0.25 0.16 0.23 0.22 0.24
E[CAV] 10,385 8,946 1,559 5,071 3,380 1,417
t ¯ 3.76 5.77 1.04 5.44 5.46 3.34
CAV
ATMoptions:Target ITMoptions:Target
All Calls Puts All Calls Puts
Sign.t-stat5%(no.) 341 343 362 393 482 396
Sign.t-stat5%(freq.) 0.18 0.18 0.19 0.21 0.26 0.21
E[CAV] 1,652 1,156 457 2,526 1,540 984
t ¯ 2.84 2.65 1.98 4.71 6.40 2.42
CAV
PanelB:Differencesincumulativeabnormalvolumeacrossmoneyness
Alloptions:Target Calloptions:Target
Diff SE p-value Diff SE p-value
OTM–ATM 3,419 722 0.00 2,224 531 0.00
OTM–ITM 2,544 669 0.00 1,840 561 0.00
ATM–ITM −874 632 0.17 −384 444 0.39
Putoptions:Target
Diff SE p-value
OTM–ATM 960 450 0.03 — — —
OTM–ITM 433 367 0.24 — — —
ATM–ITM −527 429 0.22 — — —
Notes. PanelAreportsthenumberandfrequencyofdealswithstatisticallysignificantpositivecumulativeabnormalvolumeatthe5%significance
levelforthetargetcompanies,aswellastheaveragecumulativeabnormalvolume(E[CAV])andcorrespondingt-statistic(t ¯ ),computedusing
CAV
heteroscedasticity-robuststandarderrors.Allresultsarereportedseparatelyforcalloptions,forputoptions,andfortheaggregateoptionvolume.
Resultsstratifiedbymoneynessarebasedonlyonthoseoptionsexpiringaftertheannouncementdate.Theestimationwindowstarts90daysbefore
theannouncementdateandrunsuntil30daysbeforetheannouncementdate.Theeventwindowstretchesfrom30daysbeforeuntilonedaybefore
theannouncementdate.InpanelB,wereporttheresultsoft-testsforthedifferencesintheaveragecumulativeabnormalvolumesacrossmoneyness
categories:OTM,ITM,andATM.Wereportthedifferenceinaveragecumulativeabnormalvolume(“Diff”),thestandarderror,andthep-value.
andincreasestoapproximately1,500contractstheday (puts).Thesevaluescorrespondto408(343,482)deals,
beforetheannouncement.Individually,thenumberof or22%(18%,26%)ofthesample,forOTM(ATM,ITM)
deals with positive abnormal trading volumes, at the calls, and 451 (362, 396) deals, or 24% (19%, 21%), for
5% significance level, ranges from 467 for calls to 304 OTM (ATM, ITM) puts, respectively.
forputs,correspondingtoapproximately25%and16% In panel B of Table 3, we report results from paired
oftheentiresample,respectively.6Thus,approximately t-testsforthedifferencesinthemeansofthecumulative
25% of the deals exhibit statistically significant cumu- average abnormal volumes across different categories.
lative abnormal options trading volume.7 ConsistentwithH2,theseresultsemphasizethatthereis
We further stratify our sample by moneyness and higher abnormal trading volume for OTM call options
conduct an event study for each category, using only thanforATMorITMcalls.Thedifferencesinthemeans
optionsexpiringaftertheannouncementdate.Wefind forOTMcallsrelativetoATMandITMcallsare2,224and
that there is significantly higher abnormal trading 1,840, respectively, which are positive and statistically
volume for the targets in OTM call options compared differentfromzero.Ontheotherhand,thedifferencein
withATMandITMcalls,intermsofbothvolumelevels the means between ATM and ITM calls is slightly neg-
and frequencies. Table 3 shows that the average cu- ative(−384)butnotstatisticallydifferentfromzero.The
mulativeabnormalvolumeis3,380(1,417)contractsfor average cumulative abnormal volume for ITM put op-
OTMcalls(puts)and1,540(984)contractsfortheITM tionsishigherthanforATMputoptions,whichprovides
calls (puts), whereas it is 1,156 (457) for ATM calls some evidence that informed traders may not only
Augustin,Brenner,andSubrahmanyam:OptionsTradingBeforeTakeoverAnnouncements
ManagementScience,ArticlesinAdvance,pp.1–24,©2018INFORMS 9
Q:43 Figure1. (Coloronline)AbnormalTradingVolumesBefore 4.2. Characteristics of Abnormal Volume
Announcement Dates Wenextexaminewhethercertaintargetcompaniesare
more likely than others to exhibit unusual trading
volumes. We investigate several takeover deal char-
acteristics that may imply a higher likelihood of in-
formed trading, as they are associated with greater
announcement returns. Hence, we regress the cumu-
lative abnormal log trading volume in call and put
optionsoverthe30preannouncementdaysonasetof
categoricalvariablesreflecting dealcharacteristics and
marketactivityvariables.Wefirsttestthefollowing
model:
CABVOL(cid:3)β +β SIZE+β CASH+β TOE
0 1 2 3
+β PRIVATE+β COLLAR+β TERM
4 5 6
+β FRIENDLY+β US+γ +ε,
7 8 t
(1)
where CABVOL denotes the cumulative abnormal
tradingvolumeincallorputoptions,whichwescaleforQ:17
eachtargetbytheaveragepredictedvolumeintheevent
window.9Allspecificationscontainyearfixedeffectsγ,
t
andstandarderrorsareclusteredbyannouncementday.
Our strongest prior is that cumulative abnormal
volumeshouldbehigherforcash-financeddeals,given
that they are known to have higher abnormal an-
nouncementreturns(Andradeetal.2001)andaremore
likelytobecompleted(Fishman1989).Thus,weexpect
thataninformedtraderwillbenefitmorefromtrading
ifheanticipatesahigherabnormalreturnandismore
certainthathewillearnit.Wetestforthisbyincluding
a dummy variable, CASH, that takes the value 1 for
cash-financed deals. In addition, traders with private
information may prefer opening positions for larger
Notes. In(a),wedepicttheaverageabnormaltradingvolumeforallequity companies,whosestocks(and,therefore,theiroptions)
options(solidline),calloptions(dashedline)andputoptions(dottedline),
tend to be more liquid, and hence less likely to reveal
respectively,forthetargetcompanies,overthe30-daypreannouncement
period.Volumeisdefinedasthenumberofoptioncontracts.In(b),we unusual, informed trading. Thus, we expect cumula-
depicttheaveragecumulativeabnormaltradingvolumeforalloptions tive abnormal volume to be higher for larger deals,
(solidline),calloptions(dashedline),andputoptions(dottedline)overthe measured by SIZE, a dummy variable that takes the
sameeventperiod.Statisticsarecomputedforasampleof1,859target
value1ifthedealisabovethemediantransactionvalue
companiesoverthetimeperiodJanuary1996throughDecember31,2012.
and 0 otherwise. According to Acharya and Johnson
(2010), firm size may also proxy for the number of in-
engageinOTMcalltransactionsbutalsosellITMputs.8 siderstothedealand,thus,theprobabilityofinformation
The weaker evidence that informed traders may also leakage. A bidder who has a toehold in the company
engage in writing ITM put options may be due to the (TOE) may also belikely to gather and tradeonprivate
riskynessofwritingnaked(especiallyITM)puts,asthe information about a future takeover. Alternatively,
failure of deal negotiations could lead to a sharp stock a toehold investor with privileged information may re-
price drop. Selling naked puts also requires large frain from trading as he would be among the first sus-
margins,whichmayimposebindingcapitalconstraints pects in any investigation. A foothold may also be
on traders. interpreted as publicly observable information (Jarrell
We verify our results using alternative tests and and Poulsen 1989). We also control for other deal char-
robustnesschecks.Theresultsagreewiththeprevious acteristics, such as whether the target is taken private
findings, yielding either similar or stronger results, posttakeover (PRIVATE), whether the deal has a collar
both qualitatively and quantitatively. We discuss the structure (COLLAR), whether it involves a termination
detailsofthese additionaltests in theonlineappendix feeuponthefailureofdealnegotiations(TERM),whether
Section A-II. thedealattitudeisconsideredtobefriendly(FRIENDLY),
Augustin,Brenner,andSubrahmanyam:OptionsTradingBeforeTakeoverAnnouncements
10 ManagementScience,ArticlesinAdvance,pp.1–24,©2018INFORMS
Table4. Characteristics of Cumulative Abnormal CallVolume
Variable CABVOLC CABVOLC CABVOLC I (CABVOLC) I (CABVOLC)
SIZE 3.32** 2.44* 3.31** 0.23** 0.21*
(1.34) (1.29) (1.33) (1.26) (1.24)
CASH 6.37*** 5.49*** 5.15*** 0.42*** 0.43***
(1.53) (1.54) (1.59) (1.52) (1.53)
TOE −5.58* -3.38 −4.82* -0.33 -0.27
(2.94) (2.71) (2.92) (0.72) (0.76)
PRIVATE 0.12 0.06 0.88 -0.09 −0.13
(1.97) (1.91) (2.00) (0.91) (0.88)
COLLAR 7.23** 6.47** 6.52** 0.41* 0.43**
(2.94) (2.85) (2.95) (1.50) (1.54)
TERM 5.65*** 4.57** 4.93*** 0.20 0.21
(1.83) (1.80) (1.83) (1.22) (1.23)
FRIENDLY 3.04 1.91 2.85 0.14 0.06
(2.36) (2.30) (2.37) (1.15) (1.06)
US −2.45 −1.71 −2.54 -0.35** −0.31**
(1.91) (1.88) (1.92) (0.70) (0.74)
TRUNUP 24.30*** 1.01***
(2.88) (2.75)
TANNRET 0.57 0.74
(4.56) (2.10)
TTPRET1 −7.84* −1.15**
(4.08) (0.32)
ARUNUP −4.52 4.21 -0.97**
(4.27) (4.36) (0.38)
MKTVOL −3.85** -1.91 −0.06
(1.95) (2.02) (0.94)
TOT_PREMIUM 4.24**
(1.75)
Constant −1.37 15.25* 5.68 −0.82** −0.62
(2.79) (8.66) (9.01) (0.44) (0.54)
Observations 1,859 1,859 1,859 1,859 1,859
adj.R2/ps.R2 0.056 0.123 0.060 0.035 0.054
YEARFE YES YES YES YES YES
Notes. Incolumns(1)and(2),wereportgeneralizedleastsquaresregressionresultsfromtheprojectionofcumulativeabnormalcalloptionlog-
volume(CABVOLC,standardizedbytheaveragepredictedvolumeduringtheeventwindow)onasetoftakeovercharacteristicsandmarket
activitymeasures.Columns(3)and(4)reportlogitcoefficients(oddsratiosinparentheses)fromlogisticregressionresultswherethedependent
variabletakesthevalue1ifthecumulativeabnormalcalloptionstradingvolumeduringthe30preannouncementdaysisstatisticallysignificant
atthe5%leveland0otherwise.ThevariableSIZEquantifiesthetakeoverdealvalue.ThevariableCASHisacategoricalvaluetakingthevalue1if
thedealisacash-financedtakeoverand0otherwise,TOEhasthevalue1ifabidderalreadyhasatoeholdinthetargetcompany,PRIVATEequals
1iftheacquirerprivatizesthetargetpostacquisition,COLLARtakesthevalue1fortransactionswithacollarstructure,TERMequals1fordeals
thathaveaterminationfeethatappliesifthetakeovernegotiationsfail,FRIENDLYhasthevalue1ifthedealattitudeisconsideredtobefriendly,
andUSequals1ifthebidderisaU.S.-basedcompanyand0otherwise.WedenotebyTRUNUPthepreannouncementcumulativeabnormal
stock return for the target and TANNRET the target’s announcement abnormal return; TTPRET1 refers to the target’s postannouncement
cumulativeabnormalreturn,andARUNUPistheabnormalstockreturnfortheacquirerbeforetheannouncementday.MKTVOListhemarket
volumeonthedaybeforetheannouncement.Eachregressioncontainsyearfixedeffects(“YEARFE”),andstandarderrorsareclusteredby
Q:48 announcementday.Wereportthenumberofobservations(“Observations”)andtheadjustedR2.
***,**,and*denotestatisticalsignificanceatthe1%,5%,and10%levels,respectively.
and whether the bidder is a U.S.-headquartered com- probability of information leakage (Acharya and
pany (US). Johnson 2010). Our results are similar if we proxy
The results for the benchmark regressions of cu- firm size using company sales. We also examined the
mulativeabnormalvolumeinthetargetcalloptionsare number of target and acquirer advisors as a proxy for
reportedincolumn(1)ofTable4.Wefindthatfirmsize informationleakage,buttheresultsarenotstatistically
is a significant positive predictor of abnormal options significant, similar to the findings of Heitzman and
volume.Thisevidenceisconsistentwiththeviewthat Klasa (2016). This may be due to insufficient variation
informed trading in target call options is greater for in the number of advisors for publicly traded firms
larger,moreliquidcompanies,forwhichitiseasierto (91.2%ofthesamplehasfewerthanfiveadvisors,and
hide informed trading, and when there is a greater the median is two), whereas Acharya and Johnson