Equity Short Sales and Options: Complements or Substitutes?

Abstract

This paper studies whether equity short sales and options are complements or substitutes and finds that they are substitutes when the underlying market faces short-selling constraints. This substitutability is associated with implications for stock price volatility and stock market liquidity: Stocks that are subject to short-sale restrictions and have exchange-traded options are more volatile and less liquid than both constrained stocks without options and unconstrained stocks. Traders predominantly use at-the-money options to substitute equity short sales.

Keywords: Trading restrictions, Short selling, Derivatives, Regulation

JEL Classification: G10, G14, G18