Options Trading Activity and the Efficiency of Corporate Investment

Abstract

We examine the association between active options market trading and the (in)efficiency of corporate investment in terms of deviation from optimal investment levels. Past research considers the volume of options trading as contributing to firms’ informational efficiency. Investment efficiency is partly driven by information asymmetries between firm managers and capital providers, aggravating moral hazard concerns. We test whether the enhancement in firms’ information environment associated with higher volume of options trading activity is positively related to optimizing investment at the firm level. Our results indicate that the volume of options trading by firms is positively and significantly associated with firm-level investment efficiency. This relation is associated with the enhancement in the firms’ information environment stemming from active options trading and with improved managerial learning from informed traders’ market participation. Overall, our findings suggest that managerial skills and learning associated with active trading in options markets benefit firms’ investment decisions through enhancing the optimal allocation of firm resources and investment efficiency.