The professors are so confident in their findings of pervasive insider trading that they determined statistically that the odds of the trading “arising out of chance” were “about three in a trillion.” (It’s easier, in other words, to hit the lottery.)Andrew Ross Sorkin, “Study Asserts Startling Numbers of Insider Trading Rogues”, The New York Times, 16 June 2014
Interestingly, other comments I found more recently suggest that the problem is both better (there is more enforcement than reported) and worse (other insider behaviors beyond simple call options are likely) than described in the NY Times article. Levine’s article responds to the NYT piece, but is much more in depth, as it’s written by someone very clearly comfortable with options trading.
… I mean, it’s almost too perfect. Everything you’d predict, if you were maximally cynical, the researchers found. Here are the astounding highlights:
There is abnormal options volume in the 30 days preceding a substantial minority of merger announcements.
- “The proportion of cases with abnormal volumes is relatively higher for call options (26%) than for put options (15%).”
- There’s more abnormal trading in advance of cash acquisitions than stock ones, since cash deals usually result in bigger price jumps for the target.
- “There is signiﬁcantly higher abnormal trading volume (both in average levels and frequencies) in OTM call options compared to at-the-money (ATM) and in-the-money (ITM) calls.” That is: Use of out-of-the-money call options, the most obvious way to insider trade, the Forbidden Option, increases not only absolutely but also compared with other call options in advance of a merger.
- There “is strong evidence that informed traders may not only engage in OTM call transactions, but possibly also ITM put transactions.” That is: Some people have figured out ways to trade in options that are not the Forbidden Option.
Matt Levine, “There Might Be a Lot of Insider Trading”, BloombergView, 17 June 2014
Levine goes on to analyze what the findings mean, and opines on potential interpretations. Fascinating.