Short Sale Constraints, Overvaluation, and the Introduction of Options

36 Pages Posted: 9 May 2004

See all articles by Stewart Mayhew

Stewart Mayhew

Cornerstone Research

Vassil T. Mihov

Texas Christian University - M.J. Neeley School of Business

Date Written: October 7, 2005

Abstract

We investigate whether the existence of traded options represents an economically important relaxation of short sale constraints. Our analysis has three prongs. First, to the extent that option listing relaxes a binding constraint, we would expect to see investors taking synthetic short positions in the newly-listed options. Contrary to this hypothesis, we find that the volume of newly-listed options tends to be very low, and, if anything, signed volume is more bullish that bearish during the first week of trading. Moreover, we find no significant relation between signed option volume and abnormal stock returns surrounding option listing. Second, if options help relax binding short-sale constraints, we might expect bearish option volume to be positively related to proxies for short sale constraints, divergence of opinion, and/or overvaluation. We examine nine different proxies and combinations of proxies, and in each case find either no relation, or a significant negative relation. Third, we demonstrate that prior results in the literature reporting a negative price reaction surrounding option listing are not robust to alternative methodological assumptions. All our evidence suggests that options do not reduce short sale constraints in an economically meaningful way.

Keywords: Short sales, option listing, valuation

JEL Classification: G14, G18, G19

Suggested Citation

Mayhew, Stewart and Mihov, Vassil T., Short Sale Constraints, Overvaluation, and the Introduction of Options (October 7, 2005). AFA 2005 Philadelphia Meetings, Available at SSRN: https://ssrn.com/abstract=544245 or http://dx.doi.org/10.2139/ssrn.544245

Stewart Mayhew

Cornerstone Research ( email )

1919 Pennsylvania Avenue NW
Suite 600
Washington, DC 20006-3420
United States

Vassil T. Mihov (Contact Author)

Texas Christian University - M.J. Neeley School of Business ( email )

817-257-7147 (Phone)
817-257-7227 (Fax)

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