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Failure Is an Option: Impediments to Short Selling and Options Prices

Failure Is an Option: Impediments to Short Selling and Options Prices Regulations allow market makers to short sell without borrowing stock, and the transactions of a major options market maker show that in most hard-to-borrow situations, it chooses not to borrow and instead fails to deliver stock to its buyers. A part of the value of failing passes through to options prices: when failing is cheaper than borrowing, the relation between borrowing costs and options prices is significantly weaker. The remaining value is profit to the market maker, and its ability to profit despite competition between market makers appears to result from the cost advantage of larger market makers. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Financial Studies Oxford University Press

Failure Is an Option: Impediments to Short Selling and Options Prices

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Publisher
Oxford University Press
Copyright
© The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org
Subject
Article
ISSN
0893-9454
eISSN
1465-7368
DOI
10.1093/rfs/hhm083
Publisher site
See Article on Publisher Site

Abstract

Regulations allow market makers to short sell without borrowing stock, and the transactions of a major options market maker show that in most hard-to-borrow situations, it chooses not to borrow and instead fails to deliver stock to its buyers. A part of the value of failing passes through to options prices: when failing is cheaper than borrowing, the relation between borrowing costs and options prices is significantly weaker. The remaining value is profit to the market maker, and its ability to profit despite competition between market makers appears to result from the cost advantage of larger market makers.

Journal

The Review of Financial StudiesOxford University Press

Published: May 5, 2009

Keywords: JEL Classification G12 G13 G29

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