How Do Informed Option Traders Trade? Option Trading Activity, News Releases, and Stock Return Predictability

We examine how informed traders trade in the option market around news announcements. We show that their profits depend on whether positions are long or short, whether trades take place before or after news releases, and whether events are scheduled or unscheduled. We predict and find that informed option traders use short positions only before scheduled news announcements. Purchases of options thus predict returns on news days and ahead of unscheduled events, but not before scheduled events; and sales of options are informative only ahead of scheduled news releases. We also find that informed option trading is profitable around news events, accounting for realistic measures of transaction and margin costs