The effect of option transaction costs on informed trading in the options market around earnings announcements

Abstract

We investigate the effect of option market transaction costs (a form of market imperfection) on the ability of option implied volatility‐based measures to predict future stock returns and volatility around quarterly earnings announcements. We find that the predictability is significantly stronger for firms with lower option relative bid‐ask spreads. The effect is more pronounced around positive rather than negative earnings news. We find no significant effect of option transaction costs around randomly chosen dates when there is no clustering of major information events. Trading strategies based on option market predictors and transaction costs earn monthly abnormal returns of 1.39% to 1.91%.

Informed options trading prior to FDA announcements

“…For example, Hao (2016) and Govindaraj et al. (2020) report that a one standard deviation increase in pre‐announcement implied volatility spreads is associated with a 0.30% increase in abnormal announcement returns from repurchase and earnings news, respectively. A reasonable proportion of the variation in $$AB.RET{[ 0 ]_{it}}$$ is explained by our regression models with adjusted $${R^2}$$ values between 11% and 14%.…”

“…between January 1, 1996, andDecember 31, 2016. As applied in prior studies as measures of informed trading, we use implied volatility spreads, options volume and order imbalance to capture the presence of informed options trading prior to FDA announcements (e.g., Bohmann & Patel, 2020;Cremers & Weinbaum, 2010;Govindaraj et al, 2020).…”

“…Several studies find that options volume and order imbalance can predict future stock returns (e.g., Ge et al., 2016; Johnson & So, 2012; Pan & Poteshman, 2006). Numerous studies report evidence of abnormal options trading activity and implied volatility prior to a variety of major corporate news announcements (e.g., Cairney & Swisher, 2004; Chan et al., 2015; Govindaraj et al., 2020). In addition, a meaningful fraction of price discovery is found to occur in equity and futures options markets (e.g., Bohmann et al., 2019; Patel et al., 2020).…”

“…We examine 352 FDA new drug approvals and related announcements (which we term FDA announcements) between January 1, 1996, and December 31, 2016. As applied in prior studies as measures of informed trading, we use implied volatility spreads, options volume and order imbalance to capture the presence of informed options trading prior to FDA announcements (e.g., Bohmann & Patel, 2020; Cremers & Weinbaum, 2010; Govindaraj et al., 2020). For example, prior studies find that implied volatility spreads capture the direction of informed traders’ private information.…”

Desarrollo teórico y evidencia empírica de la política de dividendos: una revisión de literatura en Iberoamérica

“…Dada la imperfección de los mercados, para el inversionista y la empresa los costos de transacción en el mercado son importantes y modifican su comportamiento al momento de comprar y vender las acciones, no solo en el hecho del intercambio, sino también al momento de tener utilidades gravables; análogamente para la empresa (Govindaraj et al, 2020); Higgins (1972), por medio de un modelo de optimización de dividendos demuestra que se puede maximizar la riqueza de los accionistas minimizando los costos de transacción, garantizando por una parte la inexistencia de excesos de liquidez en el caso de una entrega insuficiente de dividendos y evitando la necesidad de capital externo por dividendos excesivos.…”