Regulatory Uncertainty and Market Liquidity: The 2008 Short Sale Ban's Impact on Equity Option Markets




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    • Battalio and Schultz are with the Mendoza College of Business, University of Notre Dame. We thank an anonymous firm for providing the option data used in our analysis, the Options Clearing Corporation for providing early exercise and open interest data, S3 Matching Technologies and an anonymous retail broker for providing retail order and rebate rate data, and the ISE for providing data on trades that open or close trading positions. We thank Al Lemon, Hang Li, and Bill McDonald specifically and the Mendoza IT group more generally for their help in processing the OPRA data and Margaret Forster for prodding us to take on this project. We gratefully acknowledge comments from Peter Bottini, Shane Corwin, Karl Diether, Michael Doherty, Amy Edwards, Robert Jennings, Charles Jones, Carolyn Mitchell, Rob Neal, Jerry O'Connell, Gavin Rowe, Sophie Shive, Jeff Soule, and Rod Taylor; seminar participants at the University of Notre Dame, the University of Pittsburgh, the Ohio State University, the University of Oklahoma, and the University of Kentucky; and participants at the Federal Reserve Bank of Atlanta's conference “Short Selling: Costs and Benefits”; the IIROC-DeGroote 2010 Conference on Market Structure and Market Integrity; the 2nd Annual RMA-UNC Academic Forum for Securities Lending Research; and the 2010 Western Finance Association meetings.


We examine how the September 2008 short sale restrictions and the accompanying confusion and regulatory uncertainty impacted equity option markets. We find that the short sale ban is associated with dramatically increased bid-ask spreads for options on banned stocks. In addition, synthetic share prices for banned stocks become significantly lower than actual share prices during the ban. We find similar results for synthetic share prices of hard-to-borrow stocks, suggesting that the dislocation in actual and synthetic share prices is attributable to the increased hedging costs for options on banned stocks during the short sale ban.