Why Do Option Introductions Depress Stock Prices? A Study of Diminishing Short Sale Constraints

Danielsen, Bartley R.; Sorescu, Sorin M.

doi:10.2307/2676220

Cited by 316 publications

(192 citation statements)

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“…Several authors (Brent, Morse, and Stice (1990), Danielsen and Sorescu (2001), Chen and Singal (2003), and Senchak and Starks (1993)) have explored the interaction between the options market and the stock market to investigate the extent to which short-sale constraints are binding. A trader that wants to express a negative view about a security can either sell the security if he happens to own it, sell the security short, or buy at the money put options.…”

Section: Robustness Tests: Cross-sectional Differences In Short-sementioning

confidence: 99%

“…We find that short-sellers are contrarian both in stocks with high and low institutional ownership, but as expected, the magnitude of the effect of past abnormal returns on future short-sales is almost three times as high for stocks with high institutional ownership. Traders using small-size trades are contrarian following negative returns but do not respond significantly to positive abnormal returns, while those using medium-and large-sized trades are consistently contrarian.Several authors (Brent, Morse, and Stice (1990), Danielsen and Sorescu (2001), Chen and Singal (2003), and Senchak and Starks (1993)) have explored the interaction between the options market and the stock market to investigate the extent to which short-sale constraints are binding. A trader that wants to express a negative view about a security can either sell the security if he happens to own it, sell the security short, or buy at the money put options.…”

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confidence: 99%

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Can Short-sellers Predict Returns? Daily Evidence

Diether¹,

Lee

Werner

2005

SSRN Journal

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We test whether short-sellers in Nasdaq-listed stocks are able to predict future returns based on new SEC-mandated data for the first six months of 2005. There is a tremendous amount of short-term trading strategies involving short-sales during the sample: Short-sales represent 27 percent of Nasdaq share volume while monthly short-interest is about 3.1 percent of shares outstanding (5.5 days to cover). Short-sellers are on average contrarian -they sell short following positive returns. Increasing short-sales predict future negative returns, and the predictive power comes primarily from small trades. A trading strategy based on daily short-selling activity generates significant returns, but incurs costs large enough to wipe out any profits. * All three authors are at the Fisher College of Business, The Ohio State University. We are grateful for comments from Leslie Boni, Rudi Fahlenbrach, Frank Hatheway, David Musto, René Stulz, and seminar participants at the Ohio State University, the NBER Market Microstructure Group, and the University of Georgia. We thank Nasdaq Economic Research for data. All errors are our own.Many market observers accuse short-sellers of destabilizing markets by selling stocks (they do not even own) when prices are already trending downward, exacerbating the negative momentum. Issuers and journalists often characterize short-sellers' activities as immoral, unethical and downright un-American. 1 Academics and traders instead argue that short-sellers stabilize security prices by selling stocks when prices exceed fundamental values, thus helping correct market overreaction. Short-term over-reaction could be caused by impediments to short-selling, as high costs of executing short-sales may result in stock prices reflecting the opinions of optimistic investors only (Miller (1977)). 2 Some researchers have even argued that costly short-selling was one of the culprits behind the stock market bubble of the late 1990s (e.g., Ofek and Richardson (2003)).In this study, we use the SEC mandated tick-by-tick short-sale data for 2,815 Nasdaq-listed stocks for the period January 3, 2005 to June 30, 2005 to test whether short-sellers are contrarian or momentum traders and whether they are able to predict future returns. We test these hypotheses by studying the link between short-selling activity and future returns and how short-sellers react to past returns on a daily level.The literature on short-selling is growing rapidly. Most previous studies have used monthly stock-specific short interest data (e.g., Figlewski and Webb (1993), Figlewski (1981), Dechow, Hutton, Meulbroek, and Sloan (2001), Desai et al (2002), Asquith, Pathak, and Ritter (2005), and Singal and Xu (2005)). There are three important problems with using monthly short interest data.First, the monthly reporting frequency does not permit researchers to study short-term trading strategies. Second, monthly short interest data does not distinguish between the short interest of dealers (who are exempt from short-sale restrictions) from th...

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Section: Robustness Tests: Cross-sectional Differences In Short-sementioning

confidence: 99%

mentioning

confidence: 99%

Can Short-sellers Predict Returns? Daily Evidence

Diether¹,

Lee

Werner

2005

SSRN Journal

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“…Our option introduction results also contribute to the debate about whether these events depress stock prices (Danielsen and Sorescu 2001, Mayhew and Mihov 2005, Blau 2008). …”

Section: Introductionmentioning

confidence: 95%

“…Upon the introduction of tradable options, investors who face difficulty selling short underlying stocks can now alternatively sell short synthetically through the option markets (Figlewski andWebb 1993, Danielsen andSorescu 2001). Such positions involve selling calls and buying puts, prompting market makers (who are commonly the counterparty) to hedge their positions through selling short the underlying security.…”

Section: Introductionmentioning

confidence: 99%

Short-sale constraints and the idiosyncratic volatility puzzle: An event study approach

Jiang

Peterson

Doran

2014

Journal of Empirical Finance

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Using event studies, we show that short-sale constraints play an important role in the negative relation between idiosyncratic volatility and stock returns. We explore three exogenous events that change short-sale constraints: the IPO lockup period expiration, option introduction, and the recent short-selling ban on financial stocks. Following mitigation of short-sale constraints from the first two events, high idiosyncratic volatility stocks underperform low volatility stocks in the short and long run, and are associated with higher abnormal trading volume. Additionally, highly volatile financial firms experience greater price increases upon the short-sale ban enforcement and greater price drops upon the ban expiration.

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“…Restrictions on short selling then reduce the speed at which prices adjust to private information. Their study was followed by a range of empirical work that tested and ultimately found support for their predictions [e.g., Asquith and Meulbroek (1995) and Danielsen and Sorescu (2001)]. Biais, Bisiere, and Decamps (1999) find that the Paris Bourse spot market, for which short sale constraints exist, reflects good news significantly faster than bad news.…”

Section: Literature Reviewmentioning

confidence: 99%