Do Markets Anticipate Changes in Risk after Major Corporate Events? Evidence from SEOs
37 Pages Posted: 9 Apr 2013 Last revised: 26 Sep 2014
Date Written: April 9, 2013
Abstract
This paper examines the relationship between stock and option markets around SEO events. We compare option-implied volatility and realized volatility to show that option markets do not fully predict risk dynamics following equity issues. Moreover, we show that straddle strategies that explore the difference between option-implied and realized volatility following SEO events can lead to significant risk-adjusted (by common risk factors) positive returns. We also find that risk-adjusted returns can be partially explained by uncertainty (approximated for by option market liquidity). We interpret this as compensation for writing options during times of high uncertainty around the SEO event, where long options are more valuable.
Keywords: Option-implied information, seasoned equity offering, straddle, volatility trading strategy
JEL Classification: C21, G14, G32
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