Options on Initial Public Offerings

Transcription

1 Global Risk Institute workshop Thursday January 28 th, 2016 Options on Initial Public Offerings Thomas Chemmanur (Boston College) Padma Kadiyala (Pace University) Chay Ornthanalai (University of Toronto)

2 LinkedIn Helped By Lack of Shorting, Put Options There are no shares to short anywhere so it can only go one way, which is up Traders can t buy put options either, since the options market doesn t get a crack at LNKD until next week Douglas Estadt of Rand Strategic Partners Interview on WSJ.com - (19 May 2011)

3 When are options listed after IPO? Never optioned After 36 months months 7-12 months Within 6 months IPO issuance year Within 6 After 36 Never 7-12 months months All IPOs months months optioned

4 Research questions 1. What are the consequence of option listing on the equity firms that have recently gone public? Why? Is there a trading strategy? 2. Which factors determine when options are listed after the firm goes public?

5 Main result: Impact of option listing on IPO stocks Weekly CAR (%) around option listing date Raw returns Nasdaq-adjusted returns Small firmadjusted returns Matching firmadjusted returns Weeks relative to option listing date

6 Motivations IPO stocks underperforms in the long-run, i.e. short-run overvaluation (Ritter (1991)) Why?? Ritter (JF, 1991)

7 Motivations Short-run overvaluation Why?? IPO stocks are subject to significant: 1. Shortsale constraint. Houge, Loughran, Suchanek, and Yan (2001), Ljungqvist, Nanda, and Singh (2006), Geczy, Musto, and Reed (2002) Option listing relaxes shortsale constraint, e.g. Figlewski and Webb (1993), Danielsen and Sorescu (2001) 2. Heterogeneous investors belief. Miller (1977), Chemmanur and Krishnan (2012) Options market improves price discovery via increasing investors participation, e.g. Easley, O Hara, Srinivas (1998)

8 Main findings 1. IPO stock underperforms immediately after option listing Informed speculators put options to synthetically short the underlying IPO stock Short-interests trading activity triples Insiders aggressively sell their shares Significant profit from buying newly-listed put options 2. Exchanges tend to early-list options on IPOs that are: Venture capital backed Taken public by less reputable underwriter

9 Data and methods Databases: SDC platinum, OptionMetrics, CRSP, Compustat, Thomson s insider trading, I/B/E/S, First Call, Shortsqueeze. IPO sample: Focus on US offerings between 1996 to 2008 Exclude REIT, Closed-end funds, non-ordinary shares, etc. Abnormal return benchmark : (1) Firm matched by industry and size (Matching firm-adjusted) (2) CRSP-value-weighted NASDAQ ( NASDAQ-adjusted ) (3) Lowest decile of NYSE market index ( Small firm-adjusted )

10 Remaining tasks 1. Data and methods 2. Impact of option listing on IPO returns 3. Determinants of option listing on IPOs 4. Trading strategy 5. Explaining post-option-listing returns

11 Does options listing influence IPO long-run returns? Apparently so

12 Event study results: Weekly CAR relative to option listing week Event : Option listing week Event : IPO shares unlock week

13 Do IPO lockup expirations explain the results? NO Event : Option listing week Event : IPO shares unlock week

14 Do results hold across different periods? Yes

15 Remaining tasks 1. Data and methods 2. Impact of option listing on IPO returns 3. Determinants of option listing on IPOs 4. Trading strategy 5. Explaining post-option-listing returns

16 Extended Cox model We model time-to-list : number of months from IPO issuance to when options are introduced IPO variables: Percent shares locked up, Proceeds size, Lockup flag, Venture backed, First-day-return, etc. Time-varying covariates (Mayhew and Mihov (2004)): Shares turnover, Market cap, Volatility, Momentum

17 Determinants of time-to-list : Estimation Results ( 1 ) ( 2 ) ( 3 ) ( 4 ) ( 5 ) IPO Characteristics: Venture backed 0.506*** 0.546*** (6.78) (7.20) Time to lockup expiration (0.45) (0.39) High underwriter rep ** ** (-2.14) (-2.14) First day ret * * (-1.80) (-1.76) Proceeds amount 0.289*** 0.213*** 0.234*** 0.197*** 0.299*** (5.04) (3.84) (4.13) (3.54) (5.06) Time-varying covariates: Market cap 1.321*** 1.326*** 1.341*** 1.348*** 1.387*** (32.42) (32.03) (32.21) (31.23) (30.72) Shares turnover 0.102*** 0.100*** 0.100*** 0.102*** 0.102*** (7.29) (7.30) (7.22) (7.40) (7.24) Volatility 0.021* 0.028*** 0.028*** 0.030*** 0.024** (1.93) (2.67) (2.66) (2.85) (2.18) Cumulative retuns 1.131*** 1.138*** 1.140*** 1.131*** 1.130*** (9.13) (9.14) (9.17) (9.09) (9.11) Industry and year fixed effects YES YES YES YES YES Number of obervations Number of events

18 Do exchanges listing decisions change our main result? NO CAR (%) % 25% 20% 15% 10% 5% 0% -5% -10% Treated Group: Option-listed IPO Control group: Non-option-listed IPO Weeks relative to option listing date

19 Remaining tasks 1. Data and methods 2. Impact of option listing on IPO returns 3. Determinants of option listing on IPOs 4. Trading strategy 5. Explaining post-option-listing returns

20 Buying put options on IPO stocks Can we make profit from this phenomenon? Yes! Put payoff S Buy newly-listed put options on IPO stocks ( pick OTM contract and longest maturity available ) Hold them to maturity 6% average monthly returns after transaction costs

21 Excess returns from buying puts after transaction cost Higher returns for the strategy that focuses on: OTM/Long-maturity puts Venture-backed IPO firms Firms that receive options listing early IPOs with large first-day pop ITM OTM Remark: This is an event study result

22 Remaining tasks 1. Data and methods 2. Impact of option listing on IPO returns 3. Determinants of option listing on IPOs 4. Trading strategy 5. Explaining post-option-listing returns

23 Synthetic shorting using put options In ordinary short selling: Short seller must find an existing owner who is willing to lend her the share Lending fee can be very high for hard-to-borrow stocks, i.e. IPO. (Geczy, Musto, and Reed (2002)) When an investor buys a put option: Market maker hedges his position by short selling the underlying shares But he can do this cheaply! (Reg SHO) Empirical prediction: Short interests level in the security should increase tremendously

24 Changes in short interest ratio: Relative to event month -4

25 Insider selling post-option listing Why do we observe persistent underperformance up to a year after options listing? Insiders sells their shares in anticipation of price decline Certain insiders, e.g., VC, might face greater pressure than others Empirical prediction: Percentage shares held by insiders significantly decline for several months after options listing

26 Changes in insider shares holding: Relative to event month -4

27 Conclusions 1. IPO stocks underperform after options have been listed. 2. Option listing improves price discovery of newly public firms, and their timing affects IPO long-run performance. 3. Buying newly listed long-maturity put options on IPO stocks yields up to 6% return per month after transaction costs.

28 Option listing on CBOE IPO: Jun 18th 2010 Option listed: Jun 23rd 2010

29 Other on-going research projects 1. Market illiquidity: Crash risk: How does market illiquidity impact timevarying crash risk? Liquidity spillover: How does market illiquidity propagate between the equity and derivative markets? 2. Investment & security analysts: Older, Slow, and Wiser? Does decision-speed determine stock-picking ability? Paying for talent: Do funds that charge more hire better stock-picking experts?

30 Thank you GRI for your generous support