Are shorts restricted when options are an option? Evidence from SEC Rule 201

Abstract

This paper investigates the effect of the current short-sale regulation, SEC Rule 201, on cross-market trading and its impact on market quality. The evidence suggests that after Rule 201 is triggered, shorting activity decreases and put option activity increases. Call option activity, option bid-ask spreads, and pressure on put option prices increase as well. This evidence is consistent with informed short sellers migrating from the equity market to the options market after short-sale restrictions become binding and contributes to a long-standing debate on the topic. Further, we document an increase in equity bid-ask spreads and equity price dispersion, indicative of deterioration in the market quality of the underlying stocks. The evidence highlights the need of additional disclosure requirements related to large synthetic short-sale positions through options.

Keywords: option markets, short-sale regulation, Rule 201, market quality, trader migration

JEL Classification: G12, G14