Options, Short Sales, and Market Completeness

This paper presents empirical evidence that trading in options contributes to both transactional and informational efficiency of the stock market by reducing the effect of constraints on short sales. The significantly higher average level of short interest exhibited by optionable stocks supports the argument that options facilitate short selling. The authors also find significant effects on option prices related to the short interest in the underlying stock. They then present evidence that options also increase information efficiency. Earlier work, that is replicated and extended here, has suggested that short sale constraints cause stock prices to underweight negative information. Options appear to reduce that effect. Copyright 1993 by American Finance Association.

[1]  E. Miller.  Risk, Uncertainty, and Divergence of Opinion , 1977 .

[2]  R. Jennings,et al.  Earnings Announcements, Stock Price Adjustment, and the Existence of Option Markets , 1986 .

[3]  S. Ross.  Options and Efficiency , 1976 .

[4]  Douglas J. Skinner.  Options markets and the information content of accounting earnings releases , 1990 .

[5]  Kose John,et al.  Spanning the State Space with Options , 1980, Journal of Financial and Quantitative Analysis.

[6]  W. Newey,et al.  A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelationconsistent Covariance Matrix , 1986 .

[7]  Douglas J. Skinner.  Options markets and stock return volatility , 1989 .

[8]  E. Stice,et al.  Short Interest: Explanations and Tests , 1990, Journal of Financial and Quantitative Analysis.

[9]  H. White.  A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity , 1980 .

[10]  S. Ross,et al.  Option pricing: A simplified approach☆ , 1979 .

[11]  R. Jarrow.  Heterogeneous Expectations, Restrictions on Short Sales, and Equilibrium Asset Prices , 1980 .

[12]  Stephen Figlewski,et al.  The Informational Effects of Restrictions on Short Sales: Some Empirical Evidence , 1981, Journal of Financial and Quantitative Analysis.

[13]  Jennifer S. Conrad.  The Price Effect of Option Introduction , 1989 .

[14]  Sanford J. Grossman,et al.  An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies , 1987 .

[15]  Marc R. Reinganum.  Misspecification of capital asset pricing : Empirical anomalies based on earnings' yields and market values , 1981 .

[16]  Robert E. Verrecchia,et al.  Constraints on short-selling and asset price adjustment to private information , 1987 .

[17]  R. Banz,et al.  The relationship between return and market value of common stocks , 1981 .

[18]  F. Black,et al.  The Pricing of Options and Corporate Liabilities , 1973, Journal of Political Economy.