Put Options
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The story...

There was very high trading in "put options" on American Airline and United Airlines, immediately before 9/11. These were effectively gambles that their share prices would fall, which of course is what happened once the attacks took place. This shows the traders must have had advance knowledge of 9/11.

Our take...

This is a complex story, but the claims don’t always match the reality.

Although there were high volumes traded on these days, for instance, they weren’t as exceptionally high as some sites like to claim. Here’s one analysis.

There were very good reasons to sell American Airlines shares, too, as they’d just announced a string of bad news. Read more here.

United Airlines stocks were falling in price, too. If investors anticipated they were about to release bad results then their put options would also be worth buying (although keep in mind that the UAL put volumes weren’t the highest in the year anyway). Here’s our thoughts.

Some point to stories like the “unclaimed millions” from UAL puts as having a sinister explanation, but we disagree. Here’s why.

There was plenty of talk about potential insider dealings in other stocks, too. We haven’t researched these in any depth, but it’s worth pointing out that some people believe the claims were overblown.

What about most of the options being put through a CIA-linked bank? We weren’t convinced.

The 9/11 Commission Report mentions this issue in its notes to Chapter 5:

"A single U.S.-based institutional investor with no conceivable ties to al Qaeda purchased 95 percent of the UAL puts on September 6 as part of a trading strategy that also included buying 115,000 shares of American on September 10...

Similarly, much of the seemingly suspicious trading in American on September 10th was traced to a specific U.S.-based options trading newsletter, faxed to its subscribers on Sunday, September 9, which recommended these trades".

Perhaps the strongest challenge to this conclusion comes from Professor Allen M Poteshman from the University of Illinois at Urbana-Champaign. He decided to investigate this further, analysing market data statistically to try and assess the trades’ significance. Professor Poteshman points out several reasons to question the foreknowledge argument:

Despite the views expressed by the popular media, leading academics, and option market professionals, there is reason to question the decisiveness of the evidence that terrorists traded in the option market ahead of the September 11 attacks. One event that casts doubt on the evidence is the crash of an American Airlines plane in New York City on November 12. According to the OCC Web site, three trading days before, on November 7, the put-call ratio for options on AMR stock was 7.74. On the basis of the statements made about the links between option market activity and terrorism shortly after September 11, it would have been tempting to infer from this put-call ratio that terrorism probably was the cause of the November 12 crash. Subsequently, however, terrorism was all but ruled out. While it might be the case that an abnormally large AMR put-call ratio was observed by chance on November 7, this event certainly raises the question of whether put-call ratios as large as 7.74 are, in fact, unusual. Beyond the November 12 plane crash, an article published in Barron’s on October 8 (Arvedlund 2001) offers several additional grounds for being skeptical about the claims that it is likely that terrorists or their associates traded AMR and UAL options ahead of the September 11 attacks. For starters, the article notes that the heaviest trading in the AMR options did not occur in the cheapest, shortest-dated puts, which would have provided the largest profits to someone who knew of the coming attacks. Furthermore, an analyst had issued a “sell” recommendation on AMR during the previous week, which may have led investors to buy AMR puts. Similarly, the stock price of UAL had recently declined enough to concern technical traders who may have increased their put buying, and UAL options are heavily traded by institutions hedging their stock positions. Finally, traders making markets in the options did not raise the ask price at the time the orders arrived as they would have if they believed that the orders were based on adverse nonpublic information: the market makers did not appear to find the trading to be out of the ordinary at the time that it occurred.

However, he then devises a statistical model, which he suggests is consistent with foreknowledge after all:

VI. Conclusion
Options traders, corporate managers, security analysts, exchange officials, regulators, prosecutors, policy makers, and—at times—the public at large have an interest in knowing whether unusual option trading has occurred around certain events. A prime example of such an event is the September 11 terrorist attacks, and there was indeed a great deal of speculation about whether option market activity indicated that the terrorists or their associates had traded in the days leading up to September 11 on advance knowledge of the impending attacks. This speculation, however, took place in the absence of an understanding of the relevant characteristics of option market trading.

This paper begins by developing systematic information about the distribution of option market activity. It constructs benchmark distributions for option market volume statistics that measure in different ways the extent to which non–market maker volume establishes option market positions that will be profitable if the underlying stock price rises or falls in value. The distributions of these statistics are calculated both unconditionally and when conditioning on the overall level of option activity on the underlying stock, the return and trading volume on the underlying stock, and the return on the overall market. These distributions are then used to judge whether the option market trading in AMR, UAL, the Standard and Poor’s airline index, and the S&P 500 market index in the days leading up to September 11 was, in fact, unusual.

The option market volume ratios considered do not provide evidence of unusual option market trading in the days leading up to September 11. The volume ratios, however, are constructed out of long and short put volume and long and short call volume; simply buying puts would have been the most straightforward way for someone to have traded in the option market on foreknowledge of the attacks. A measure of abnormal long put volume was also examined and seen to be at abnormally high levels in the days leading up to the attacks. Consequently, the paper concludes that there is evidence of unusual option market activity in the days leading up to September 11 that is consistent with investors trading on advance knowledge of the attacks.

One issue that troubles us about this is the lack of analysis of the string of bad news delivered by American Airlines on September 7th, the trading day before September 10th, when the most significant trading occurred. Professor Poteshman told us via email:

My study does include quantile regressions that account for the market conditions on particular stocks. Hence, there is at least a first order correction for the negative news that was coming out on Sept. 7 on AMR.

But can you really treat the news so simply? Professor Paul Zarembka supports the claims, saying:

Poteshman finds ... these purchases [of options on American Airline stock] ... had only 1 percent probability of occurring simply randomly...

But we’re not saying they were random, rather that they may have been a rational response to significant bad news delivered the day before. Poteshman is essentially saying (with regard to AMR) is that people bought too many puts for that to be explained by the 9/7 news, therefore another explanation is required, but how can you say that without analysing the news itself? After all, if that news had been “we’ll probably be bankrupt in six months” then the put ratios would probably have been even more significant, and Poteshman’s model given even more confirmation of “unusual option market activity”, but would that have made the idea of foreknowledge more likely? We don’t think so. Obviously the AMR news was less significant, but we would still say that you cannot accurately judge the significance of these trades until you take it into consideration.

Another complication here comes in the fact that put volumes in these shares were normally low, from what we’ve read, and this obviously makes it easier for spikes to appear. The 9/11 Commission said:

A single U.S.-based institutional investor with no conceivable ties to al Qaeda purchased 95 percent of the UAL puts on September 6 as part of a trading strategy that also included buying 115,000 shares of American on September 10. Similarly,much of the seemingly suspicious trading in American on September 10 was traced to a specific U.S.-based options trading newsletter, faxed to its subscribers on Sunday, September 9, which recommended these trades...

The September 6th UAL puts would automatically appear significant, then, even though only one investor was reportedly behind them. But does that really mean you can mathematically indicate it’s likely that investor had foreknowledge of 9/11, without considering the other market conditions and information available at the time?

And it’s a similar story with the AMR trades. Newsletters and share tipsters do deliver spikes in trading every day, at least here in the UK. There was bad news on Friday that may well have justified the newsletter suggesting puts be purchased (and if that news had leaked or been suspected prior to release then you might have an explanation for earlier purchases, too). Professor Poteshman appears to be saying that the traders were more pessimistic about the future of AMR than they should have been, that they over-reacted to the news and bought more puts than he’d expect, but then perhaps his statistics were based primarily on trades being individual decisions (an institution or private individual decides to buy some puts). Newsletters aren’t always like that. Many are purchased by people who do little research themselves, and simply follow the recommendations provided. Therefore if the author of the newsletter says “buy puts”, then that’s what many of them will do, and the higher the circulation of the newsletter, the greater the resulting spike of “abnormal trades” will be.

Anyway, Screw Loose Change raised a similar issue or two that you might want to consider. And please don’t end this here: go read Poteshman’s paper, just to assess this for yourself. If you’re not great at statistics then some of it will make your eyes glaze over, guaranteed, but there are also interesting comments that are accessible to everyone, so overall it’s well worth a read.

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