The Options Market Maker Exception to SEC Regulation SHO

54 Pages Posted: 11 Sep 2010 Last revised: 5 Nov 2013

See all articles by Thomas Stratmann

Thomas Stratmann

George Mason University - Buchanan Center Political Economy; CESifo (Center for Economic Studies and Ifo Institute)

John W. Welborn

Dartmouth College

Date Written: April 24, 2012

Abstract

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.

Keywords: short selling, settlement failure, stock lending, rules

Suggested Citation

Stratmann, Thomas and Welborn, John W., The Options Market Maker Exception to SEC Regulation SHO (April 24, 2012). Journal of Financial Markets, Volume 16, Issue 2, May 2013, Pages 195–226. Available at SSRN: https://ssrn.com/abstract=1675234 or http://dx.doi.org/10.2139/ssrn.1675234

Thomas Stratmann (Contact Author)

George Mason University - Buchanan Center Political Economy ( email )

4400 University Drive
Fairfax, VA 22030
United States
703-993-2330 (Phone)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

John W. Welborn

Dartmouth College ( email )

Department of Sociology
Hanover, NH 03755
United States

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