Companies have collected billions in premiums from privately sold put options written on their own stock. It is puzzling that counterparties, investment banks, would agree to make such transactions with better-informed companies which have extraordinary ability to time the market as documented by Jenter et al. (2011). To resolve this puzzle, we develop a model that shows that investment banks, by offering to buy put options from better-informed parties, receive private information about issuing companies. Our model also incorporates the practice of firms (such as Microsoft) of sometimes repurchasing their own put options and thus providing additional private information to investment banks. Empirically, we find support for our theory from an abnormal 9% increase in the stock prices and a 40% increase in the trading volumes around the put sales. Examination of 13D filings reveals that trading by upper management insiders cannot completely account for the change in volume.
Bibliographical noteFunding Information:
We thank Vladimir Atanasov for significant contributions on an earlier draft. We are also grateful to Avi Bick, Audra Boone, Riccardo Calcagno, Valentina Corradi, Douglas Cumming, Scott Gibson, Jeremy Goh, Michael Gombola, Hristo Gyoshev, Nigar Hashimzade, David Haushalter, Eric Higgins, Shawn Howton, Michael Jensen, Jayant Kale, Yoram Kroll, Robin Mason, Arie Melnik, Roni Michaely, Alvaro Nascimento, Andrey Pavlov, Efrat Shust, Kenneth Singleton, Theo Vermaelen, as well as two referees and Bart Lambrecht. We also want to thank participants at seminars at the FDIC, Bentley College, Durham University, Drexel University, Simon Fraser University, University of Exeter, University of Haifa, and the World Finance Conference. Finally, we also thank Daniel Amona, and Evelyn Robinson for help with data-collection, Jonathan Moore and Sandra Sizer for editorial assistance, Craig McEwan for beyond the usual database support, and especially Shan Wu and Shenqiu Zhang for their innovative data manipulation and skillful computations. This research did not receive any specific grant from funding agencies in the public, commercial, or non-for-profit sectors.
- Information acquisition
- Put options
- Separating equilibrium
- Strategic trading
ASJC Scopus subject areas
- Business and International Management
- Economics and Econometrics
- Strategy and Management