Regulatory Uncertainty and Market Liquidity: The 2008 Short Sale Ban's Impact on Equity Option Markets

Abstract

We examine how the September 2008 short sale restrictions and the accompanying confusion and regulatory uncertainty impacted equity option markets. We find that the short sale ban is associated with dramatically increased bid-ask spreads for options on banned stocks. In addition, synthetic share prices for banned stocks become significantly lower than actual share prices during the ban. We find similar results for synthetic share prices of hard-to-borrow stocks, suggesting that the dislocation in actual and synthetic share prices is attributable to the increased hedging costs for options on banned stocks during the short sale ban.This ban is terrible for option market makers. It will kill options trading because you cannot price options fairly. You cannot buy a call or sell a put and hedge them.

Distribution of Ownership, Short Sale Constraints, and Market Efficiency: Evidence from Cross‐Listed Stocks

“…Indeed, Battalio and Schultz (2011) find that although trading volume in options remained relatively stable during the ban, the cost of implementing synthetic short positions during that period increased significantly. Indeed, Battalio and Schultz (2011) find that although trading volume in options remained relatively stable during the ban, the cost of implementing synthetic short positions during that period increased significantly.…”

“…5 The ban produced positive and statistically significant excess returns among short sale banned stocks (Autore, Billingsley, and Kovacs, 2011). In addition, it intensified individual stock return comovements with the overall market (Lobanova, Hamid, and Prakash, 2010) and caused an increase in options trading costs and trading volumes (Battalio and Schultz, 2011;Grundy, Lim, and Verwijmeren, 2012). In addition, it intensified individual stock return comovements with the overall market (Lobanova, Hamid, and Prakash, 2010) and caused an increase in options trading costs and trading volumes (Battalio and Schultz, 2011;Grundy, Lim, and Verwijmeren, 2012).…”

Short‐Selling Risk

“…To test the impact of impediments to short selling, existing studies examine a wide variety of potential measures of short sale constraints including regulatory action (Jones (), Diether, Lee, and Werner (), Battalio and Schultz (), Boehmer, Jones, and Zhang ()), institutional ownership (Asquith, Pathak, and Ritter (), Nagel ()), the availability of traded options (Figlewski and Webb (), Danielsen and Sorescu ()), and current loan fees (Jones and Lamont (), Cohen, Diether, and Malloy ()). However, all of these are static measures of short sale constraints (i.e., they examine how conditions today constrain short sellers), while we focus on the dynamics of short selling constraints (i.e., we examine how the risk of changing future constraints impacts short sellers).…”

Are single stock futures used as an alternative during a short‐selling ban?

“…Counter-intuitively, Battalio and Schultz (2010) find that short-sellers did not shift to options as an alternative to short-selling. Grundy, Lim, and Verwijmeren (2012) provide similar evidence on the reaction of options markets to the US short-sale ban.…”