Abstract
In an attempt to increase the competitiveness and the efficiency of electronic trading on the six US option exchanges, the Securities and Exchange Commission (SEC) recently issued a new rule (the so called Penny-Pilot program) that required a significant reduction in the tick size of more than 370 stocks. One obvious consequence of this new rule was a reduction in the transaction or execution costs in options trading. This new regulation provides a natural experiment to investigate the extent to which execution costs of options trading interacts with their underlying stocks. In this paper, we investigate whether the Penny-Pilot program encourage investors to migrate their trading from the equity market to the options market e.g. by substituting short selling for put buying. Our results show that traders did indeed switch their trades. Overall, our results are consistent with the SEC’s stated mission of improving the option trading environment especially via reducing individual investors’ execution cost.
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