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Abstract

This study investigates the impact of reducing the contract size threshold for off-market trading on transaction costs in an options market. This study provides evidence that market makers compete more aggressively for small-to-medium trades and quote mid-size depths more often after the regime change. Results also indicate that small-to-medium trades incur lower transaction costs; however, large trades that are executed on the central limit order book do not benefit from the structural transition. Given recent frictions imposed by regulators on equity markets, these results suggest that options markets provide an effective means for investors to replicate short-selling in underlying securities. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:361–377, 2010