I've written (in Tradestream the book and on this blog) about the abnormal returns of corporate insiders. Investors following insider moves by following corporate managers' regulatory filings can capture some of this return. Read more about my Insider Trading Dashboard. Essentially, given their stature within their firms and their own profit motives, insider transactions provide relatively accurate signals as to where management sees their stock prices moving. This strategy is predicated on mimicking insider trading moves that insiders do publicly. But what if insiders are selling off their stock ownership by hedging their holdings less publicly (in forms 3, 4, and 5 and mostly in footnotes)? Bettis, Bizjak, and Kalpathy recently published a study on insiders hedging their stock ownership. In Why Do Insiders Hedge their Ownership? An Empirical Examination, the researchers describe 4 common techniques that insiders use to hedge their holdings and future stock price results depend upon which vehicle chosen:
- equity swaps (or total return equity swaps: insiders exchange future returns on their stock for the cash flows of another financial instrument
- zero-cost collars: involves a simultaneous purchase of a put and sale of a call
- forwards: combines a forward sale of the insider's stock to another institution, depending upon the value of the stock at a future date
- exchange funds: a group of insiders place their shares in a limited partnership or LLC. By contributing their shares into a diversified portfolio, insiders can diversify their holdings.
- exchange funds: stock price continued to climb
- collars and forwards: saw a reversal in firm performance after the hedge was put on