Informed Trading and Option Prices: Evidence from Activist Trading

Using a comprehensive sample of trades from Schedule 13D filings by activist investors, we study how option prices respond to informed trading in the stock market. We show that this class of informed traders chooses to trade stocks and to not trade derivatives in more than 97% of cases, suggesting that most of informed trading by activist shareholders takes place in the stock market. We find that on days when activists accumulate shares, option implied volatility decreases and volatility skew increases. These changes are consistent with the drop in realized volatility we observe around the filing date. We also find that measures of adverse selection increase for options but decrease for stocks on days when Schedule 13D filers trade in stocks. Option markets seem to reflect valuable volatility specific information.