Short Sales and Option Listing Decisions

Abstract

This study tests the hypothesis that exchanges choose to list options for stocks that experience high levels of short activity. Results show that short activity is markedly higher for stocks that list options than for stocks that are eligible but do not list during the month prior to the option introduction. This result holds when controlling for other know determinants of the listing decision. The abnormal pre-listing short activity is driven by stocks that are most likely to face binding short-sale constraints indicating that exchanges not only look at short activity but short activity in stocks that are costly to short. Our final set of tests examines post-listing option volume and shows that option volume is increasing in the level of pre-listing short activity. Interestingly, when controlling for short activity, some of the other known determinants become orthogonal to post-listing option volume.