Informed Trading in the Stock Market and Option-Price Discovery

Pierre Collin-Dufresne, Vyacheslav Fos and Dmitry Muravyev

Journal of Financial and Quantitative Analysis, 2021, vol. 56, issue 6, 1945-1984

Abstract: When activist shareholders file Schedule 13D filings, the average stock-price volatility drops by approximately 10%. Prior to filing days, volatility information is reflected in option prices. Using a comprehensive sample of trades by Schedule 13D filers that reveals on what days and in what markets they trade, we show that on days when activists accumulate shares, option-implied volatility decreases, implied volatility skew increases, and implied volatility time slope increases. The evidence is consistent with a theoretical model where it is common knowledge that informed trading occurs only in the stock market and market makers update option prices based on stock-price and order-flow dynamics.

Date: 2021
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