Information Content of Options Trading Prior to Dividend Initiations

Abstract

This article utilizes options 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.