The Options Market Maker Exception to SEC Regulation SHO
George Mason University - Buchanan Center Political Economy; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
John W. Welborn
George Mason University
April 24, 2012
Journal of Financial Markets, Forthcoming
Until 2008, options market makers engaged in bona fide market making were exempt from locate and certain close out requirements for short sales (the “Exception”). This Exception applied only to short sales that qualified as bona fide hedges of options positions that were established before a stock went on the SEC Regulation SHO Threshold List. In this paper we examine the consequences of eliminating this close-out Exception. Specifically, we test the hypothesis that eliminating the Options Market Maker Exception to SEC Regulation SHO reduced the incentive to naked short sell stocks through the options market. We compare data from the second and fourth quarters of 2008. Consistent with our predictions, we find that eliminating the Exception led to fewer fails-to-deliver and higher stock borrow rates for optionable stocks as compared to non-optionable stocks. Further, removing the Exception reduced fails-to-deliver for optionable stocks when the price of borrowing stock was high. Finally, options market trading volume declined after the Exception was eliminated.
Number of Pages in PDF File: 54
Keywords: short selling, settlement failure, stock lending, rulesAccepted Paper Series
Date posted: September 11, 2010 ; Last revised: May 18, 2012
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