Options and the Bubble




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    • Both authors, Mendoza College of Business, University of Notre Dame. We thank Morgan Stanley & Co., Inc. for financial support. The views expressed herein are solely those of the authors and not those of any other person or entity including Morgan Stanley. We thank an anonymous firm for providing the option data used in our analysis. We gratefully acknowledge comments from seminar participants at the University of North Carolina, the University of Notre Dame, the 2005 American Finance Association meetings, the 2005 Morgan Stanley Equity Microstructure Conference, the 2005 Western Finance Association meetings, Marcus Brunnermeier, Shane Corwin, Tim Loughran, Stewart Mayhew, Allen Poteshman, Matthew Richardson, Robert Whitelaw, and an anonymous referee.


Many believe that a bubble existed in Internet stocks in the 1999 to 2000 period, and that short-sale restrictions prevented rational investors from driving Internet stock prices to reasonable levels. In the presence of such short-sale constraints, option and stock prices could decouple during a bubble. Using intraday options data from the peak of the Internet bubble, we find almost no evidence that synthetic stock prices diverged from actual stock prices. We also show that the general public could cheaply short synthetically using options. In summary, we find no evidence that short-sale restrictions affected Internet stock prices.