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Informational Content of Option Volume Prior to Takeovers

Author

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  • Charles Quanwei Cao

    (Pennsylvania State University University Park, The Mary Jean and Frank P. Smeal College of Business Administration, Department of Finance)

  • Zhiwu Chen

    (Yale University, International Center for Finance)

  • John M. Griffin

    (Yale University, School of Management)

Abstract

This paper examines the information embedded in both the stock and option markets prior to takeover announcements. During normal periods, buyer-seller initiated stock volume imbalances are significant predictors of next-day stock returns and option volume imbalances are uninformative. However, prior to takeover announcements, call volume imbalances are strongly positively related to next-day stock returns. Cross-sectional analysis shows that those takeover targets with the largest pre-announcement call-imbalance increases experience the highest announcement-day returns. The largest increase in buyer-initiated trading activity is in short-term out-of-the-money calls that subsequently experience the largest returns. Collectively, these findings are consistent with the hypothesis that, in the presence of pending extreme informational events, the options market plays an important role in price discovery.

Suggested Citation

  • Charles Quanwei Cao & Zhiwu Chen & John M. Griffin, 2003. "Informational Content of Option Volume Prior to Takeovers," Yale School of Management Working Papers ysm422, Yale School of Management.
    • Handle: RePEc:ysm:somwrk:ysm422
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