Substitution between Short Selling and Options Trading in Predicting Aggregate Stock Returns

50 Pages Posted: 31 May 2019

See all articles by Shiyang Huang

Shiyang Huang

The University of Hong Kong - Faculty of Business and Economics

Tse-Chun Lin

The University of Hong Kong - Faculty of Business and Economics

Weinan Zheng

The University of Hong Kong Faculty of Business and Economics

Date Written: March 2019

Abstract

Splitting stocks into groups with and without options trading, we find that only the aggregate short interest index constructed by the stocks without options trading predicts market returns in both in-sample and out-of-sample tests. The return predictability is up to six months and does not revert. Similarly, when splitting stocks into groups based on short selling risks, we find only the aggregate option implied volatility spread constructed by the stocks with higher short selling risks predicts market returns. Overall, our results show that there exists a substitution effect between short selling and options trading in predicting aggregate stock returns. This substitution effect could explain the phenomena that aggregate short interest does not predict market returns in recent years, given the rapid development of the options market.

Keywords: Aggregate Short Interest; Options Trading; Market Return; Out-of-Sample Tests; Informed Traders

JEL Classification: C58, G12, G14, G17

Suggested Citation

Huang, Shiyang and Lin, Tse-Chun and Zheng, Weinan, Substitution between Short Selling and Options Trading in Predicting Aggregate Stock Returns (March 2019). Available at SSRN: https://ssrn.com/abstract=3372333 or http://dx.doi.org/10.2139/ssrn.3372333

Shiyang Huang

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Tse-Chun Lin

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Weinan Zheng (Contact Author)

The University of Hong Kong Faculty of Business and Economics ( email )

Hong Kong
(+852) 5547-5290 (Phone)

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