Informed Options Trading prior to M&A Announcements: Insider Trading?∗

We investigate informed trading activity in equity options prior to the announcement of corporate mergers and acquisitions (M&A). For the target companies, we document pervasive directional options activity, consistent with strategies that would yield abnormal returns to in-vestors with private information. This is demonstrated by positive abnormal trading volumes, excess implied volatility and higher bid-ask spreads, prior to M&A announcements. These ef-fects are stronger for out-of-the-money (OTM) call options and subsamples of cash offers for large target firms, which typically have higher abnormal announcement returns. The probabil-ity of option volume on a random day exceeding that of our strongly unusual trading (SUT) sample is trivial- about three in a trillion. We further document a decrease in the slope of the term structure of implied volatility and an average rise in percentage bid-ask spreads, prior to the announcements. For the acquirer, we provide evidence that there is also unusual activity in volatility strategies. A study of all Securities and Exchange Commission (SEC) litigations involving options trading ahead of M&A announcements shows that the characteristics of insider trading closely resemble the patterns of pervasive and unusual option trading volume. Histor