Dividend Initiations, Information Content and Informed Trading in the Options Market

Abstract

We find that informed trading in the option market prior to dividend initiation is negatively related to announcement period price reactions. This relation is more prevalent among firms with abnormal trading in call options, higher stock price runup, and higher option liquidity. We also find improvements in stock liquidity following dividend initiation. The improvement in stock liquidity is positively related to the increase in institutional investors’ holdings, and negatively related to the relative size of the dividend initiation payment and preannouncement option trading. We further find positive abnormal earnings following dividend initiation. Overall, these findings indicate that dividend initiation conveys information regarding sustainable future earnings and improvements in liquidity, and informed traders are active in the option market prior to dividend initiation.

Keywords: Dividend initiations, options trading, O/S, call/put options, volatility surface, abnormal earnings, stock liquidity

JEL Classification: G12, G13, G14, G32