Informed Option Trading of Target Firms' Rivals Prior to M&A Announcements

Utilizing a sample of 1899 M&A events from 1996 to 2020, we observe positive and significant abnormal trading volumes in the option market of target firms' rivals, particularly in out-the-money options. Our analysis further explores the underlying reasons for these patterns based on two major theories from existing literature: the acquisition probability theory, which suggests that rivals of target firms experience abnormal returns due to the increased likelihood of future acquisitions, and the collusion theory, which asserts that horizontal mergers lead to enhanced market power and, consequently, abnormal returns for rivals. Our findings support the acquisition probability theory.