Option Prices and Costly Short-Selling

62 Pages Posted: 1 Feb 2017 Last revised: 17 Jul 2018

See all articles by Adem Atmaz

Adem Atmaz

Purdue University - Krannert School of Management

Suleyman Basak

London Business School; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2018

Abstract

Much empirical evidence shows that stock short-selling costs and bans have significant effects on option prices. We reconcile these findings by providing a dynamic analysis of option prices with costly short-selling and option marketmakers. In our framework, short-sellers incur a shorting fee to borrow stock shares from lenders, who only partially lend their long positions. We obtain simple, closed-form, unique option bid and ask prices that represent option marketmakers' expected hedging costs, and are weighted-averages of well-known benchmark prices (Black-Scholes, Heston). Consistent with evidence, we show that bid-ask spreads of typical options, put option implied volatilities, and apparent put-call parity violations are increasing in the shorting fee. Our analysis also uncovers several novel predictions, most notably, option bid-ask spreads are decreasing in the partial lending, the option marketmakers’ participation in the stock lending market is decreasing in the shorting fee for each call option sold, and the effects of short-selling costs on option bid-ask spreads are more pronounced for relatively illiquid options. We also apply our methodology to corporate bonds, which have option-like payoffs.

Keywords: Option prices, short-selling, shorting fee, partial lending, options marketmaking, bid-ask spreads, put-call parity violations, short-selling bans, stochastic volatility

JEL Classification: G12, G13, G23

Suggested Citation

Atmaz, Adem and Basak, Suleyman, Option Prices and Costly Short-Selling (July 2018). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2909473 or http://dx.doi.org/10.2139/ssrn.2909473

Adem Atmaz (Contact Author)

Purdue University - Krannert School of Management ( email )

403 West State Street
West Lafayette, IN 47907
United States

HOME PAGE: http://www.aatmaz.com

Suleyman Basak

London Business School ( email )

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Regent's Park
London, London NW1 4SA
United Kingdom
44 (0)20 7000 8256 (Phone)
44 (0)20 7000 8201 (Fax)

HOME PAGE: http://www.suleymanbasak.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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