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Why do investment banks buy put options from companies?
Journal article   Open access   Peer reviewed

Why do investment banks buy put options from companies?

Stanley B. Gyoshev, Todd R. Kaplan, Samuel H. Szewczyk and George P. Tsetsekos
Journal of corporate finance (Amsterdam, Netherlands), v 67, 101718
Apr 2021
DOI: https://doi.org/10.1016/j.jcorpfin.2020.101718
url
https://hdl.handle.net/10871/122471View
Accepted (AM)CC BY-NC-ND V4.0,  Open

Abstract

Information acquisition Put options Screening Separating equilibrium Strategic trading
Companies have collected billions in premiums from privately sold put options written on their own stock. It is puzzling that counterparties, investment banks, would agree to make such transactions with better-informed companies which have extraordinary ability to time the market as documented by Jenter et al. (2011). To resolve this puzzle, we develop a model that shows that investment banks, by offering to buy put options from better-informed parties, receive private information about issuing companies. Our model also incorporates the practice of firms (such as Microsoft) of sometimes repurchasing their own put options and thus providing additional private information to investment banks. Empirically, we find support for our theory from an abnormal 9% increase in the stock prices and a 40% increase in the trading volumes around the put sales. Examination of 13D filings reveals that trading by upper management insiders cannot completely account for the change in volume. •Firms significantly profited from privately selling put options on their own stock.•We model how investment banks gain private info about the firms by buying the puts.•We find abnormal increases of 12% in prices and 40% in volumes around put sales.•13D filings reveals that upper management insiders increased their long position.•Findings support the theory that investment banks gain from the info they acquire.

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Web of Science research areas
Business, Finance
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