Uncategorized

Should investors run for the doors when they see an insider hedging?

close

Email a Friend

Should investors run for the doors when they see an insider hedging?

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:

  1. equity swaps (or total return equity swaps: insiders exchange future returns on their stock for the cash flows of another financial instrument
  2. zero-cost collars: involves a simultaneous purchase of a put and sale of a call
  3. forwards: combines a forward sale of the insider’s stock to another institution, depending upon the value of the stock at a future date
  4. 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.

Intuitively, the researchers typically found a significant price run-up before these hedging transactions.  Stock performance varied depending upon which hedge was used:

  • exchange funds: stock price continued to climb
  • collars and forwards: saw a reversal in firm performance after the hedge was put on

The big takeaway here for investors is that after a significant appreciation in a heavily management-owned stock, certain hedges can signal opportunistic trading, even if no stock is formally sold.

Source

Why do insiders hedge their ownership? An empirical examination (Bettis, Bizjak and Kalpathy), November 2010

0 comments on “Should investors run for the doors when they see an insider hedging?”

Uncategorized

The Daily Tearsheet: A day in the life of Kristen Anderson, the CEO and co-founder of Catch

  • In this daily, we've got a day in the life of Kristen Anderson, the CEO and co-founder of Catch
  • And in other news, NFTs continue to spread.
Rivka Abramson | May 03, 2022
Uncategorized

Job Opening: People Person

  • Tearsheet is growing and looking to hire a People Person.
  • You'll help us source and grow new talent for our team.
Tearsheet Editors | December 09, 2021
Uncategorized

Job Opening: Audio-Visual Editor

  • Tearsheet's podcasts, webinars, and conferences are industry favorites.
  • We're looking for a ninja editor to take our audio/visual content to the next level.
Arifah Esar | January 01, 2021
Uncategorized

Careers at Tearsheet – Journalist

  • Tearsheet is an impactful media organization, helping its audience understand the impact technology has on financial services.
  • We're always looking for great writing talent to add to our team and organization.
Aaron Singer | January 01, 2021
Uncategorized

Careers at Tearsheet: Online Marketing Specialist

  • Tearsheet is an impactful media organization, helping its audience and partners understand the impact technology has on financial services.
  • We're always looking for great talent to add to our teams and organization.
Aaron Singer | August 19, 2020
More Articles