Profit from Insider Sales by Short Selling: New Evidence

Monkeying insider purchases has been a very profitable investment strategy. Insiders usually own a lot of stocks and/or options in their companies. Increasing concentration of wealth in a single stock usually is not rational. Random events may strike the company and the investor might lose most of the wealth in a heartbeat (i.e. Bear Stearns and Lehman Brothers insiders). So when insiders take the risk of buying more shares, usually it’s because they know something we don’t. That’s why imitating insider purchases is such a rewarding strategy.

On the other hand, selling is the rational thing to do for most insiders even when they think they expect slightly better results from their companies. The benefits of diversification compensate for the loss of future stock returns. Of course selling is the right thing to do when insiders are pessimistic about the future. As a result insider sales is much more common than insider purchases, but the act is much less informative. Insider sales have been intensifying during the past two decades as insiders receive increasing quantities of stock and option awards. There’s now a greater need to diversify compared to 10 or 20 years ago.

Academic research on insider sales has revealed that imitating all insider sales transactions is not profitable. It’s because most insider sales transactions are done for diversification or demand for liquidity. So, the lists of the largest insider sales published in the Wall Street Journal or Barron’s really don’t mean much.

However, it’s possible to get rid of the noise in insider sales transactions and develop a potentially profitable investment strategy. A 2009 research paper by Alan Jagolinzer (Stanford University) analyzed insider transactions conducted under the protection of Rule 10b5-1. The SEC enacted Rule 10b5-1 to protect insiders’ preplanned, non-information based trades from litigation. When Angelo Mozillo was selling his Countrywide shares in the millions, he was doing so under a 10b5-1 plan. Jagolinzer found that insiders participate in these plans preceding negative firm performance. A substantial proportion of plans were initiated before adverse news disclosures. Jagolinzer also found evidence of early terminations of the plans when there was pending positive firm performance.

Jagolinzer also calculated market adjusted buy and hold returns for stocks sold under 10b5-1 plans. These stocks underperform the market by 70 basis points for a 1-month holding period. The underperformance is 220 basis points for a 3-month horizon and 360 basis points for a 6-month horizon. Alternatively, this strategy’s alpha was calculated using Carhart’s four factor model. Insiders who participated in a 10b5-1 plan and sold their holdings had a monthly alpha of 70 basis points (t-stat=-2.28). That’s consistent with buy-and-hold abnormal returns. Insiders who didn’t participate in a 10b5-1 plan and sold their shares in the open market had a negative alpha of 50 basis points (t-stat=1.93) per month, meaning the stocks beat the market after the insiders sold them.

These are very promising results. The only drawback of Jagolinzer’s study is that it covers the 2000-2005 period, a relatively short period from which to draw a definitive conclusion. If the results held up during the post-2005 period, they could be used to create a very profitable short selling strategy.

blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

The 10 Most Expensive Clothing Stores in the United States to Get Decked Out At

The 5 Biggest Kickstarter Scams That Swindled Backers’ Donations

The 10 Most Expensive Boarding Schools In the World

50 Crazy Facts About Japan You Won’t Believe

Top 10 Least Expensive Hybrid Cars to Save the Planet With

The 10 Biggest ‘Gate’ Controversies in History

The 10 States with the Highest Nursing Shortages Leaving Their Hospitals Depleted

The 10 Best Value Investment Blogs that Every Investor Must Read

The 6 Cheapest Boarding Schools in Europe 2015

The 5 Most Expensive Cars To Insure in the World

The 10 Most Common Genetically Modified Foods

10 Self-Made Billionaires Who Came From Nothing

The 10 Most Expensive Cities to Live in North America

The 13 Most Expensive Headphones in the World to Represent

The Top 20 Wealthiest Soccer Teams in 2014

4 BuzzWorthy Cannabis Stocks And Some Smoking Derivative Plays

The 10 Healthiest Fast Food Chains in America to Dine At

The 5 Most Expensive Cat Food Brands You Can Spoil Your Kitty With

The 6 Best eCommerce Platforms for Small Businesses

The 10 Worst Mistakes an Entrepreneur Can Make

The 5 Most OP Characters in League of Legends to Carry Games and Crush Foes With

The 5 Best Foods to Eat Before Running that Will Help You Pound the Pavement

10 Glaring Plot Holes in The Walking Dead that a Zombie-Filled Bus Could Drive Through

The 5 Biggest Celebrity Stoners Who Love Their Reefer

The 10 Most Overrated Movies Of All Time by Out-of-Touch Critics

Top 6 Least Expensive Cruise Destinations For 2015 that Will Take You to Paradise

10 States with Lowest Substance Abuse Rates in America

The 14 Most Watched TV Finales Ever

The 10 Best Selling Role Playing Games of All Time for PC

10 Most Influential Papers In Economics

Top 8 Biggest Charities in the US

10 Worst Celebrity Career Moves Ever

Top 10 Best Paid Tennis Stars in the World

Top 6 Cities For The Ultra Rich to Live in Comfort

10 Cities with High Demand for Nurses

6 of the Worst Greeting Card Messages Ever Crafted

How to Make Money in ArcheAge and Build Your Empire

10 Foods To Eat To Lower Cholesterol Levels

The 10 Most Hated Television Characters of All Time

The 30 Worst Halloween Costume Ideas Ever Brought to Horrible Life

10 Vocational Skills in Demand Today with Jobs Waiting to be Filled

10 Best Places to Visit in Central and South America

The 10 Greatest Empires in History Which Nearly Conquered the World

The 6 Cheapest Boarding Schools In America 2015

5 Clear Reasons LoL is Better than DotA, Continues to Rule MOBAs

The Only 9 Teams with a Chance to Win the Super Bowl

The 15 Most Common Phobias in America that Induce Fits of Panic

Top 6 Least Expensive Tourist Destinations in 2014

Jim Goetz, Peter Fenton, Jim Breyer: Top 6 Venture Investors for 2014

Top 15 Billionaires in 2014

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!