Informational Content of Option Volume Prior to Takeovers

Charles Cao, Zhiwu Chen and John M. Griffin
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John M. Griffin: McCombs School of Business, University of Texas at Austin

The Journal of Business, 2005, vol. 78, issue 3, 1073-1109

Abstract: Which market attracts informed investors prior to extreme informational events? We examine the information embedded in the stock and option markets prior to takeover announcements. Normally, buyer-seller initiated stock volume imbalances are predictors of next-day stock returns and option volume is uninformative. However, prior to takeover announcements, call-volume imbalances are strongly related to next-day stock returns. Cross-sectional analysis shows that takeover targets with the largest preannouncement call-imbalance increases experience the highest announcement-day returns. These findings suggest that, with pending extreme informational events, the options market plays an important role in price discovery.

Date: 2005
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