The impact of short sale restrictions on informed trading in the stock and options markets

- We examine the impact of short sale restrictions (SSR) on the price discovery process between equity options and their underlying stocks.
- We utilize a new measure to capture price discovery and informed trading - option information leadership shares (OILS).
- We examine the emergency order SSR of 2008 and shows it directly affects the price discovery process.
- OILS results indicate that informed traders move to trading in markets that are unaffected by the restrictions.

This paper examines the impact of short sale restrictions (SSR) on the price discovery process of stocks and their corresponding options. We utilize a new measure to examine the impact these restrictions have on information efficiency between the two instruments. Based on one year of intraday data surrounding the US emergency order of 2008, we find evidence of traders switching from SSR restricted products to a matched group of stocks and options. At the same time there is a decline in the role options provided to price discovery in the SSR affected stocks, along with a significant rise in the importance of options for the matched sample as informed traders move to trading in markets that are unaffected by the restrictions. From a policy perspective our results indicate that a greater consideration needs to be made for the impact SSR has on trade informativeness and the price discovery process, as well as how it affects the inter-related markets through the trader-switching effect.