Purpose This study examines the association between options trading and the tax avoidance practices of firms whose shares underlie these contracts. We develop the argument that options trading is related to tax avoidance through differences in firms' information environments and financial constraints, and we present evidence consistent with these channels. Design/methodology/approach Using 52,478 US observations from 1996–2022, we measure options trading using annual dollar options volume and capture tax avoidance through GAAP, cash, and current effective tax rates. We estimate panel regressions and assess robustness through alternative measures, instrumental-variable estimation, entropy balancing approach, and two quasi-natural experiments – the penny pilot program and the introduction of weekly options. Structural equation modeling is used to test information asymmetry and financial constraints as mediating channels, and additional cross-sectional tests examine the moderating roles of analyst coverage and audit quality. Findings We document that greater options trading is associated with lower levels of corporate tax avoidance. The results remain consistent when employing alternative measures of both options activity and tax avoidance, as well as when applying the instrumental variable approach, the entropy balancing approach, and two quasi-natural identification strategies. Mediator analysis provides evidence consistent with information asymmetry and financial constraints as potential channels underlying the negative association between options trading and tax avoidance behavior. In addition, cross-sectional evidence reveals that the negative association between options trading and tax avoidance is stronger among firms with lower analyst coverage and weaker audit quality. Originality/value This study is the first to examine the association between external options trading and corporate tax avoidance and to provide evidence consistent with transmission through information asymmetry and financial constraints.
Zadeh et al. (Tue,) studied this question.