Options on Initial Public Offerings
October 31, 2013 Leave a comment
Options on Initial Public Offerings
Thomas J. Chemmanur Boston College – Carroll School of Management
Chayawat Ornthanalai University of Toronto – Rotman School of Management
Padmaja Kadiyala Pace University – Lubin School of Business
August 1, 2013
Rotman School of Management Working Paper No. 2311317
Abstract:
Using a sample of IPOs from 1996 to 2008, we examine, for the first time in the literature, the determinants and consequences of option listing on the equity of newly public firms. We explore four important issues. First, we study the determinants of the time to list options following the IPO and find that options are listed earlier on venture backed firms and those with larger IPO proceeds, but later on IPOs with higher reputation underwriters. Second, we analyze the effect of option listing on subsequent long-run stock returns and find significant under-performance persisting for more than a year after listing. This under-performance is greater for venture backed firms, but smaller for IPOs underwritten with higher reputation underwriters. Third, we test three hypotheses regarding the causes of equity under-performance post option listing and find the following: a significant increase in the short-interest ratio after option listing, indicating a relaxation of the short-sale constraint on the IPO firm equity; a significant decrease in insider equity holdings in the IPO firm in the months following option listing, indicating significant insider selling of the stock; and significantly higher put prices relative to call prices for several months following option listing, indicating that informed speculators are using put options to take short positions in the IPO firm stock during this period. Finally, we analyze the profitability of investment strategies in the newly listed options on IPO firm equity, and find significant excess returns from investing in long-maturity put options and holding them to maturity.
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