Information Content of Options Trading Prior to Dividend Initiations

Abstract

This article utilizes option markets to determine the information content of dividend-initiation announcements. Pre-event informed options trading, measured by abnormal implied volatility spread and skew, predicts the cumulative abnormal returns around dividend-initiation announcements. Options trading is more informative on dividend-initiation announcement returns when the options market is more liquid, the underlying stock market is less informed, and the dividend initiations are of a greater surprise to the market. The results are robust to a randomization test and support the conclusion that pre-event options trading contains information about the market reaction to dividend-initiation announcements.

TOPICS: Derivatives, options, legal/regulatory/public policy, information providers/credit ratings

Key Findings

• • The information content of options trading is stronger when the options market is more liquid relative to the underlying stock market.

• • The information content of options trading is higher when the dividend-initiating firms have relatively lower pre-initiation cash flows.

• • The predictive power of informed options trading is weaker when the underlying stock market is subject to more-informed trading.