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Note the date of publication: Tuesday, May 7, 2013
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This is a slightly different type of post than I normally write. Let me know what you think about it on Twitter (@OphirGottlieb).
Here's my conclusion up-front:
In my opinion, the use of options to garner unfair (read: illegal) financial gains through the use of private/insider information is a legitimate phenomenon that is identifiable on a case-by-case basis (read three articles included below as heuristic examples), as well as in a broader analysis.
Bottom line, yeah, the cheaters are using options. Or so I think...
I did a study (using Livevol data) -- or really an "analysis" -- of option trading trends before a takeover is announced and compared those trends to the six months prior to the takeover announcement. The idea was actually inspired by Reuters (and one of their immensely talented writers, Doris Frankel) which came to us with the intriguing question, "does the option market reflect the potential misuse of insider information prior to takeovers?"
While answering that question is a bit ambiguous (see analysis below), IMHO, yes, there is a trend, and yes, there are cheaters. A lot of them. Now that doesn't come as a surprise to most of you reading the blog - somehow I have turned into the lightning rod for opinions on insider trading, but let's look at data rather than opinions (even though my opinions are much more fun!)
The Set-up:
1. We looked at the top 100 takeovers from Jan 1 2012 to Aug 2012.
2. We looked at the average option volume (puts and calls separately) for the six-months prior to the takeover stopping five-days prior to the announcement.
e.g. Takeover Date Jun 7, we looked at average option volume from Jan 1 - Jun 1.
3. We then compared #2 with the average option volume five days prior to the takeover (continuing the example above, we looked at the average option volume Jun 2- Jun 6).
To add a little flavor to the mundane number crunching, I have posted several articles in specific that dealt with highly suspicious option trading prior to a takeover. I have included just a few of those below for reference below (and I do mean, "just a few" of the ones I have written):
2-14-2013
HJ Heinz (HNZ) - Takeover and a Cheater? Maybe...
12-20-2012
NYSE Euronext (NYX) -- Unusual Trading in NYX Takeover and Potential Hidden Trades
9-27-2010
AirTran (AAI) - Lucky Bet or Cheater in Takeover?
The Results
We can see:
1. On average option volume increased 67% in the five days prior to a takeover when compared to the six-months prior.
2. On average call option volume increased 71% in the five days prior to a takeover when compared to the six-months prior.
3. On average put option volume increased 60% in the five days prior to a takeover when compared to the six-months prior.
Pretty compelling evidence... But, we can also see that the standard deviation of the daily average option volumes was about 2x higher surrounding the takeover.
In English, option volume was much higher and the volatility of volume was much higher in the five days surrounding a takeover. For you Stats 101 guys, yes, this would fail a test for significance, but this is finance -- tests of significance aren't necessarily the point...
OK, so what is the point? In my opinion, the use of options to garner unfair (read: illegal) financial gains through the use of private/insider information is a legitimate phenomenon that is identifiable on a case-by-case basis (read those three articles for example), as well as in a broader analysis.
Bottom line, yeah, the cheaters are using options. Or so I think...
This is trade analysis, not a recommendation.
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were their 100 takeovers in approximately 6 months? Also, can't we just trace back the volume on those days to an individual account and put that trading desk in jail? what's the problem here?
ReplyDelete"The Set-up:
1. We looked at the top 100 takeovers from Jan 1 2012 to Aug 2012"
I have no doubt that is the case. I have been in five situations where I was in a trade because I suspected takeover due to options activity.....APKT, LIFE, AMLN, POT (when bhp made a bid) and each one of those had unusual activity in a few days leading upto it.
ReplyDeleteHaven't we gone over this? The stock market would be nothing without cheaters. It's legal if you're a politician or member of congress.
ReplyDeleteIs it possible that these so-called options cheaters are simply reading signals from underlying equity trading volumes? perhaps you could analyze trading activity in the equity market as well?
ReplyDeleteQuite true and reading the tape confirms the same. Please continue posting articles such as this.
ReplyDeleteMaybe I'm missing the point. Don't we who follow unusual options activity gain an advantage by carefully monitoring these unusual trades. Let the regulators (I know joke) go after the insiders. We can follow this activity, and with good money management be able to profit ourselves.
ReplyDeleteJust my 1/2 cents
Did you check for fundamental analysis that suggested that these stocks were ripe for a takeover? Did you check for evidence that the particular industry group was ripe for mergers and acquisitions? Did you check for firms with excess cash who, by combining the operations of the firms, synergies would exist? It does not appear that you used fundamental research to give clues as to whether these applied. If they did, speculators would use Options as a substitute for the stock to reduce their risk and to gain leverage. Good analysis of the fundamentals start speculation which feeds upon itself and causes rumors which brings a way of "followers". Using only a part of the evidence causes bad results - such as this.
ReplyDeleteI ran a study several years ago on a years data of suspicious block options trades and also got some interesting results.
ReplyDeleteDave
Not doubting your conclusion but wondering why would put volume increase also?
ReplyDeletePuts are calls. Long put + long stock = long call. Also, selling a put to buy a call is an eve more leveraged play. The fact that the volume increase is about the same is circumstantial evidence of both these types of trades. Never never never look at call and put volume as directional until you see the whole picture. Synthetic calls (or synthetic puts) by use of the other option type and stock are the norm, not the unusual.
ReplyDelete