Hostname: page-component-848d4c4894-xfwgj Total loading time: 0 Render date: 2024-06-26T19:31:07.491Z Has data issue: false hasContentIssue false
  • English
  • Français

Overcoming Arbitrage Limits: Option Trading and Momentum Returns

Published online by Cambridge University Press:  05 October 2023

Abhay Abhyankar ,
Ilias Filippou Open the ORCID record for Ilias Filippou [Opens in a new window]  and
Pedro A. Garcia-Ares
Abhay Abhyankar
Affiliation:
MOVE abyanka@gmail.com
Ilias Filippou*
Affiliation:
Washington University in St. Louis Olin School of Business
Pedro A. Garcia-Ares
Affiliation:
Instituto Tecnológico Autónomo de México (ITAM) Department of Finance pedro.garcia@itam.mx
*
iliasfilippou@wustl.edu (corresponding author)
Get access Rights & Permissions [Opens in a new window]

Abstract

Momentum profits depend mainly on the short leg and therefore on barriers to short sales. Our research indicates that the decline in momentum profitability in the past 2 decades is driven partly by a contemporaneous growth in stock options trading. Stock options offer an alternative to short selling, augmenting the stock lending market, and thereby contributing to improved pricing efficiency. The resulting reduction in barriers to short sales contributes to lower returns to momentum trading from the short leg. Our results persist after matching stocks with and without options based on different firm-level characteristics.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 59 , Issue 1 , February 2024 , pp. 97 - 120
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

We thank Jennifer Conrad (the editor) and Paul Schultz (the referee) for constructive and helpful comments on a previous version of the article. We thank Turan Bali, Martijn Boons, Tarun Chordia (discussant), Vicente Cuñat, Zhi Da, Kent Daniel, Christian Dorion, Joseph Engelberg, Matthias Fleckenstein (discussant), Christopher Jones, Alberto Manconi, Asaf Manela, Thomas Maurer, Tobias Moskowitz (discussant), Stefan Nagel, Sophie Ni (discussant), Francisco Perez Gonzalez, Christopher Polk, Melissa Prado, David Rapach, Alexi Savov, Joel Shapiro, Chardin Wese Simen (discussant), Stijn Van Nieuwerburgh, Aurelio Vasquez, Mungo Wilson, Fernando Zapatero, Guofu Zhou, and seminar participants at the 2021 American Finance Association (AFA) Annual Meeting, 2019 World Symposium on Investment Research (WSIR), 2019 Paris December Finance Meeting, 2018 Northern Finance Association (NFA) Conference, 2018 Finance Forum, SAEe 2018 Conference, Olin Business School, Nova Business School, ESADE, and ITAM for very useful comments.

References

Amin, K.; Coval, J. D.; and Seyhun, H. N.. “Index Option Prices and Stock Market Momentum.” Journal of Business, 77 (2004), 835–874.CrossRefGoogle Scholar
Asness, C. S.; Moskowitz, T. J.; and Pedersen, L. H.. “Value and Momentum Everywhere.” Journal of Finance, 68 (2013), 929–985.CrossRefGoogle Scholar
Avramov, D.; Chordia, T.; Jostova, G.; and Philipov, A.. “Anomalies and Financial Distress.” Journal of Financial Economics, 108 (2013), 139–159.CrossRefGoogle Scholar
Bali, T. G.; Cakici, N.; and Whitelaw, R. F.. “Maxing Out: Stocks as Lotteries and the Cross-Section of Expected Returns.” Journal of Financial Economics, 99 (2011), 427–446.CrossRefGoogle Scholar
Bali, T. G., and Hovakimian, A.. “Volatility Spreads and Expected Stock Returns.” Management Science, 55 (2009), 1797–1812.CrossRefGoogle Scholar
Bali, T. G., and Murray, S.. “In Search of a Factor Model for Optionable Stocks.” Available at SSRN 3487947 (2019).CrossRefGoogle Scholar
Barberis, N., and Thaler, R.. “A Survey of Behavioral Finance.” In Handbook of the Economics of Finance, Vol 1, Constantinides, G. M., Stulz, R. M., and Harris, M., eds. Amsterdam, Netherlands: North-Holland (2002).Google Scholar
Battalio, R., and Schultz, P.. “Regulatory Uncertainty and Market Liquidity: The 2008 Short Sale Ban’s Impact on Equity Option Markets.” Journal of Finance, 66 (2011), 2013–2053.CrossRefGoogle Scholar
Beneish, M. D.; Lee, C. M.; and Nichols, D. C.. “In Short Supply: Short-Sellers and Stock Returns.” Journal of Accounting and Economics, 60 (2015), 33–57.CrossRefGoogle Scholar
Blocher, J., and Ringgenberg, M.. “Stock Options, Stock Loans, and the Law of One Price.” Available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3087563 (2018).CrossRefGoogle Scholar
Blocher, J., and Whaley, R. E.. “Two-Sided Markets in Asset Management: Exchange-Traded Funds and Securities Lending.” Vanderbilt Owen Graduate School of Management Research Paper (2016).Google Scholar
Cao, J.; Goyal, A.; Ke, S.; and Zhan, X.. “Option Trading and Stock Price Informativeness.” Available at SSRN 3401806 (2019).CrossRefGoogle Scholar
Chordia, T.; Subrahmanyam, A.; and Tong, Q.. “Have Capital Market Anomalies Attenuated in the Recent Era of High Liquidity and Trading Activity?” Journal of Accounting and Economics, 58 (2014), 41–58.CrossRefGoogle Scholar
Cremers, M., and Weinbaum, D.. “Deviations from Put-Call Parity and Stock Return Predictability.” Journal of Financial and Quantitative Analysis, 45 (2010), 335–367.CrossRefGoogle Scholar
Danielsen, B. R., and Sorescu, S. M.. “Why Do Option Introductions Depress Stock Prices? A Study of Diminishing Short Sale Constraints.” Journal of Financial and Quantitative Analysis, 36 (2001), 451–484.CrossRefGoogle Scholar
Doidge, C.; Karolyi, G. A.; and Stulz, R. M.. “The U.S. Listing Gap.” Journal of Financial Economics, 123 (2017), 464–487.CrossRefGoogle Scholar
Evans, R. B.; Geczy, C. C.; Musto, D. K.; and Reed, A. V.. “Failure is an Option: Impediments to Short Selling and Options Prices.” Review of Financial Studies, 22 (2008), 1955–1980.CrossRefGoogle Scholar
Fama, E., and French, K.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “A Five-Factor Asset Pricing Model.” Journal of Financial Economics, 116 (2015), 1–22.CrossRefGoogle Scholar
Fama, E. F., and MacBeth, J. D.. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607–636.CrossRefGoogle Scholar
Figlewski, S., and Webb, G. P.. “Options, Short Sales, and Market Completeness.” Journal of Finance, 48 (1993), 761–777.CrossRefGoogle Scholar
Filippou, I.; Garcia-Ares, P.; and Zapatero, F.. “Demand for Lotteries: The Choice Between Stocks and Options.” Available at SSRN 3016462 (2020).Google Scholar
Filippou, I.; Gozluklu, A. E.; and Taylor, M. P.. “Global Political Risk and Currency Momentum.” Journal of Financial and Quantitative Analysis, 53 (2018), 2227–2259.CrossRefGoogle Scholar
Goyal, A., and Jegadeesh, N.. “Cross-Sectional and Time-Series Tests of Return Predictability: What Is the Difference?” Review of Financial Studies, 31 (2017), 1784–1824.CrossRefGoogle Scholar
Grossman, S. J. “An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies.” Journal of Business, 61 (1988), 275–298.CrossRefGoogle Scholar
Grundy, B. D.; Lim, B.; and Verwijmeren, P.. “Do Option Markets Undo Restrictions on Short Sales? Evidence from the 2008 Short-Sale Ban.” Journal of Financial Economics, 106 (2012), 331–348.CrossRefGoogle Scholar
Hanson, S. G., and Sunderam, A.. “The Growth and Limits of Arbitrage: Evidence from Short Interest.” Review of Financial Studies, 27 (2014), 1238–1286.CrossRefGoogle Scholar
Harvey, C. R.; Liu, Y.; and Zhu, H.. “… and the Cross-Section of Expected Returns.” Review of Financial Studies, 29 (2016), 5–68.CrossRefGoogle Scholar
Hoberg, G.; Kumar, N.; and Prabhala, N.. “Buy-Side Competition and Momentum Profits.” Review of Financial Studies, 35 (2022), 254–298.CrossRefGoogle Scholar
Hong, H.; Lim, T.; and Stein, J. C.. “Bad News Travels Slowly: Size, Analyst Coverage, and the Profitability of Momentum Strategies.” Journal of Finance, 55 (2000), 265–295.CrossRefGoogle Scholar
Hou, K.; Xue, C.; and Zhang, L.. “Digesting Anomalies: An Investment Approach.” Review of Financial Studies, 28 (2014), 650–705.CrossRefGoogle Scholar
Hou, K.; Xue, C.; and Zhang, L.. “Replicating Anomalies.” NBER Working Paper No. 23394 (2017).CrossRefGoogle Scholar
Hu, J. “Option Listing and Information Asymmetry.” Review of Finance, 22 (2018), 1153–1194.CrossRefGoogle Scholar
Israel, R., and Moskowitz, T. J.. “The Role of Shorting, Firm Size, and Time on Market Anomalies.” Journal of Financial Economics, 108 (2013), 275–301.CrossRefGoogle Scholar
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48 (1993), 65–91.CrossRefGoogle Scholar
Kahle, K. M., and Stulz, R. M.. “Is the U.S. Public Corporation in Trouble?” Journal of Economic Perspectives, 31 (2017), 67–88.CrossRefGoogle Scholar
Mayhew, S., and Mihov, V.. “How Do Exchanges Select Stocks for Option Listing?” Journal of Finance, 59 (2004), 447–471.CrossRefGoogle Scholar
McLean, R. D., and Pontiff, J.. “Does Academic Research Destroy Stock Return Predictability?” Journal of Finance, 71 (2016), 5–32.CrossRefGoogle Scholar
Muravyev, D.; Pearson, N. D.; and Pollet, J. M.. “Why Do Price and Volatility Information from the Options Market Predict Stock Returns?” Available at SSRN 2851560 (2020).Google Scholar
Nagel, S. “Short Sales, Institutional Investors and the Cross-Section of Stock Returns.” Journal of Financial Economics, 78 (2005), 277–309.CrossRefGoogle Scholar
Novy-Marx, R. “Is Momentum Really Momentum?” Journal of Financial Economics, 103 (2012), 429–453.CrossRefGoogle Scholar
Ofek, E.; Richardson, M.; and Whitelaw, R. F.. “Limited Arbitrage and Short Sales Restrictions: Evidence from the Options Markets.” Journal of Financial Economics, 74 (2004), 305–342.CrossRefGoogle Scholar
Pástor, L., and Stambaugh, R. F.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), 642–685.CrossRefGoogle Scholar
Shumway, T., and Warther, V. A.. “The Delisting Bias in CRSP’s Nasdaq Data and its Implications for the Size Effect.” Journal of Finance, 54 (1999), 2361–2379.CrossRefGoogle Scholar
Sorescu, S. M. “The Effect of Options on Stock Prices: 1973 to 1995.” Journal of Finance, 55 (2000), 487–514.CrossRefGoogle Scholar
Stambaugh, R. F.; Yu, J.; and Yuan, Y.. “The Short of It: Investor sentiment and Anomalies.” Journal of Financial Economics, 104 (2012), 288–302.CrossRefGoogle Scholar
Stambaugh, R. F.; Yu, J.; and Yuan, Y.. “The Long of It: Odds That Investor Sentiment Spuriously Predicts Anomaly Returns.” Journal of Financial Economics, 114 (2014), 613–619.CrossRefGoogle Scholar
Supplementary material: PDF

Abhyankar et al. supplementary material

Abhyankar et al. supplementary material

Download Abhyankar et al. supplementary material(PDF)
PDF 99 KB