Artikel Inter Sap 10 - Opsi PDF

Review of Finance Advance Access published October 14, 2015
Review of Finance, 2015, 1–33

doi: 10.1093/rof/rfv052
How Do Short-Sale Costs Affect Put

Options Trading? Evidence from
Separating Hedging and Speculative
Downloaded from http://rof.oxfordjournals.org/ at University of West Florida Libraries on June 6, 2016

Shorting Demands*
Tse-Chun Lin and Xiaolong Lu
Faculty of Business and Economics, University of Hong Kong
Abstract
We find that put options trading volume and bid-ask spreads both increase with
equity lending fees. However, we also find that put options trading volume de-
creases with lending fees for banned stocks during the 2008 Short-Sale Ban period,
when only options market makers could short. By separating the speculative de-
mand of short sellers from the hedging demand of options market makers in the
lending market, our results provide a thorough analysis of the interaction between
the options market and the equity lending market. We also shed light on the substi-
tutability/complementarity between put options volume and short interest shown in
the literature.
JEL classification: G11, G12, G14
1. Introduction
There are two arguments in the existing literature regarding the relationship between the
options market and the equity lending market. One stream of research proposes that bear-
ish options trading and equity short selling are substitutes. For example, Lamont and
Thaler (2003) examine mispricing in cases of stock carve-outs and find that investors buy
put options as substitutes when short selling is expensive. Ofek, Richardson, and Whitelaw
(2004) find that stocks exhibit more severe violations of put-call parity when short selling
becomes more costly. The other strand of research argues that put options and equity short
* The authors are grateful to valuable comments from an anonymous referee, Utpal Bhattacharya,
Lauren H. Cohen, Chen Lin, Elvira Sojli, Jared Stanfield, Wing Wah Tham, Patrick Verwijmeren, and
Yuhang Xing. They also thank conference participants at the 27th Australasian Finance and
Banking Conference; seminar participants at the Erasmus University, National Chengchi University,
National Taiwan University, National Tsing Hua University, and University of Hong Kong for their
helpful comments. Any remaining errors are their own responsibility.
C The Authors 2015. Published by Oxford University Press on behalf of the European Finance Association.
V
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2 T.-C. Lin and X. Lu
sales display a certain degree of complementarity. For example, Figlewski and Webb
(1993) find a positive relationship between the existence of options and the short interest,
due to the hedging activities of options market makers and professional traders. Battalio
and Schultz (2011) and Grundy, Lim, and Verwijmeren (2012) both show that bid-ask
spreads of put options increase dramatically among financial stocks during the 2008 Short-
Sale Ban period. They argue that this finding is consistent with the high hedging costs for
put options that market makers face for financial stocks.
In this article, we incorporate the two arguments to elucidate the interaction between
short selling and put options trading by disentangling the speculative demand of short sell-
ers from the hedging demand of options market makers in the equity lending market. On

the one hand, informed traders can capitalize on their negative private information by buy-
ing put options or selling stocks short. Short-selling costs on the underlying equities can
thus affect the options market via the demand-side channel by swaying informed traders to-
ward trading put options when short-sale costs are relatively high. On the other hand, op-
tions market makers need to hedge their short positions in put options by short selling the
underlying stocks. Via this supply-side channel, short-selling costs can negatively influence
the market making of put options.
We contribute to the literature on both options and short selling by proposing and test-
ing the two following hypotheses. Our first hypothesis concerns how short-sale costs, in
terms of equity lending fees, relate to put options trading in general. Specifically, we pro-
pose that informed traders or hedgers will turn to the options market when short selling
becomes too expensive, which implies that put options trading volume and put options bid-
ask spreads will increase with lending fees. Our second hypothesis concerns how this posi-
tive association between short-sale costs and put options trading volume would change if
demand in the equity lending market is driven solely by the hedging needs of put options
market makers. Specifically, we propose that put options trading volume will drop and that
put options bid-ask spreads will increase with lending fees, that is, the hedging costs of put
options makers, indicating a certain degree of complementarity between the two markets.
The main challenge in testing these two hypotheses is that it is not straightforward to
empirically explicate the two aforementioned short selling demands. Higher short-sale costs
not only shift investors from the lending market to the options market but also reduce the
market making of put options because short selling is necessary for put options market
makers to hedge risk. Thus, the implication of higher short-sale costs for changes in put op-
tions trading volume is ambiguous. The effect depends on the relative magnitudes of the in-
ward shift of the supply curve of put options (due to market makers’ higher hedging costs)
and the outward shift of the demand curve (due to informed traders’ higher speculative
demand).
The key innovation of this article is that we utilize the 2008 Short-Sale Ban to tease out
the speculative demand in the equity lending market because only options market makers
were allowed to short stocks on the banned list during the banned period. For the banned
stocks during the 2008 Short-Sale Ban period, short-sale costs only affect the hedging de-
mand of put options market makers; thus, this specific setup provides us with a relatively
clean test of the supply-side channel.1 By synthesizing the two channels with daily lending
1 We acknowledge that the Short-Sale Ban period was an unusual period of increased stock
spreads, increased uncertainty, potentially increased information asymmetries, and increased pric-
ing power for market makers, who alone could hedge long exposure to financial stocks by
Short Selling and Options Trading 3
fees and options trading data, we can provide direct evidence on the interaction between
put options trading and short selling.
Following Saffi and Sigurdsson (2011), we measure short-sale costs by equity lending
fees. Based on Battalio and Schultz (2011) and Grundy, Lim, and Verwijmeren (2012), put
option trading costs are proxied by bid-ask spreads. Put options trading volume is meas-
ured by the natural logarithm of the aggregated daily put options trading volume scaled by
the stock trading volume (P/S ratio). To test the first hypothesis of the relationship between
put options and short sales, we perform two separate regressions with either the P/S ratio or
the put options bid-ask spread as the dependent variable. The key independent variable is
the equity lending fee, and we control for numerous firm-level and option-level characteris-

tics that are important but sometime ignored in the previous work. We find that the put op-
tions bid-ask spread and the put options trading volume both increase with equity lending
fees, which indicates that the outward shift of the demand curve dominates the inward shift
of the supply curve in the options market. These results support our first hypothesis and
suggest that equity short sales and put options are substitutes for one another in general.
Next, we use the 2008 Short-Sale Ban to test the second hypothesis. The Short-Sale Ban
prohibited short selling on approximately 1,000 US listed firms during the period from
September 19, 2008, to October 8, 2008. Because only options market makers were exempt
from the Short-Sale Ban, the size of the lending fee for a given stock will not influence the
demand shift from short selling to put options during the ban period by traders who are not
market makers. The lending fee thus only affects the put options market via market makers.
To test whether high hedging costs induce an inward shift of the put options supply curve,
we add a banned dummy variable that indicates banned stocks during the banned period
and its interaction term with the lending fee variable into the regressions. The coefficient on
the interaction terms indicates whether the impact of lending fees on put options trading
differs during the Short-Sale Ban period.
We find that for banned stocks during the banned period, put options trading volume
decreases with the lending fee, whereas the put options bid-ask spread increases with the
fee. This result suggests that the “complementarity” between put options trading and short
selling indeed arises from the supply-side channel in the options market. Nevertheless,
when investors are allowed to short, the relationship between options and equity lending
markets is dominated by the substitution effect that arises from the speculative demand of
informed traders.
We perform two additional tests to better understand the interaction between the two
markets. First, we find that the price of put options, proxied by the implied volatility, is
positively associated with the lending fee and that the relationship is stronger for banned
stocks during the banned period. This result is consistent with our hypotheses. Second, we
examine the influence of short-sale costs on the no-arbitrage condition of put-call parity
and the implied volatility smirk. We find that equity lending fees significantly impact both
deviations from put-call parity and the pattern of the implied volatility smirk. Similarly, the
effect is stronger for banned stocks during the 2008 Short-Sale Ban. This finding suggests
that the price efficiency of puts is negatively related to short-sale costs.
short-selling stocks. However, our hypothesis testing hinges on identifying the interaction effect
between the banned dummy and stock lending fees on options trading activities, while the banned
dummy itself would partially capture the aforementioned peculiarities of financial stocks in the
financial crisis.
As robustness checks, we re-test the two hypotheses by using a two-stage least squares
(2SLS) regression model in the spirit of Grundy, Lim, and Verwijmeren (2012). Grundy,
Lim, and Verwijmeren (2012) argue that a 2SLS analysis alleviates the concern that the
results are driven by the simultaneous determination of the put options trading volume
and the put options bid-ask spread. Our findings are robust to this 2SLS estimation. We
also find qualitatively similar results when we extend the 2SLS estimation by incorporat-
ing the equity lending fee to mitigate the concern that equity lending fees and put options
trading proxies can both be simultaneously determined. Moreover, we use an alternative
measure of put options trading volume as a robustness check. Following Pan and
Poteshman (2006), we use the put-call ratio (the ratio P/(P þ C)) to capture the put op-

tions trading volume, and the results remain qualitatively the same. Finally, we conduct a
sub-sample analysis by including only banned firms during the 2008 Short-Sale Ban and
find consistent results.
Our study is closely related to Ofek, Richardson, and Whitelaw (2004), Battalio and
Schultz (2011), and Grundy, Lim, and Verwijmeren (2012). The main contribution of our
article is that we exploit the circumstances of the 2008 Short-Sale Ban to distinguish the
speculative demand of investors from the hedging demand of options market makers in
the equity lending market. In Battalio and Schultz (2011) and Grundy, Lim, and
Verwijmeren (2012), the impact of the 2008 Short-Sale Ban on put options market mak-
ers’ hedging cost is proxied by a dummy variable indicating banned stocks during the
banned period. However, the dummy variable also captures the endogenous characteris-
tics of financial stocks subject to the Short-Sale Ban and the deteriorated macro-economic
situation for financial stocks within the banned period, that is, the peak of the financial
crisis.
Additionally, the banned dummy variable might also capture (i) the fact that options
market makers can no longer delay delivering shares sold short when conducting hedging
activities, due to the elimination of the option market maker exception to Regulation SHO
(Stratman and Welborn, 2013); (ii) the policy uncertainty faced by market participants,
including options market makers (Battalio and Schultz, 2011; Grundy, Lim, and
Verwijmeren, 2012); and (iii) an increase in informed trading, found in Kolasinski, Reed,
and Thornock (2013). Therefore, the banned dummy coefficient measures both the influ-
ence of the Short-Sale Ban policy on put options trading and the fundamental nature of fi-
nancial stocks in the financial crisis.
Our article differs from previous papers in employing the interaction between the
banned dummy and the lending fee. We thus directly investigate the impact of hedging costs
on put options market making while teasing out the contaminating influence of short sell-
ers’ speculative demands. In particular, our results show that the banned dummy variable
loses its explanatory power with regard to the put options trading volume when we add the
equity lending fee and various firm characteristic control variables to the analysis. This ob-
servation highlights the necessity of studying the hedging cost of put options market makers
directly if the research agenda is to have a more complete picture of how the two markets
interact with each other.
The remainder of the article is organized as follows. Section 2 reviews the related litera-
ture. Section 3 discusses our data. Section 4 presents the empirical results for the two main
hypotheses. Section 5 presents the estimated results for additional tests and robustness
checks. Section 6 concludes.
2. Related Literature
Our study aims to provide a comprehensive framework that captures how the equity
lending market interacts with the put options market. As discussed in Section 1, there are
two distinct demands in the equity lending market: the shorting demand of informed
traders and the hedging demand of options market makers. Short-selling costs of underly-
ing equities can thus affect put option trading activities via the demand-side channel
or the supply-side channel in the options market. However, the existing literature
usually focuses on just one of them. This section provides a brief review of previous
studies.

2.1 Short Selling and Put Options As Substitutes for Informed or Hedging
Traders—Demand-Side Channel
Diamond and Verrecchia (1987) and Easley, O’Hara, and Srinivas (1998) hypothesize that
when short selling is expensive, establishing short positions in the options market can be an
alternative for informed investors to establishing short positions. Lamont and Thaler
(2003) examine three cases of US equity carve-outs and find that put options on subsidiary
stocks are much more expensive than call options on such stocks, which implies that in-
vestors who bet against these stocks create synthetic short positions in the options market
because of high associated short-sale costs. In the same vein, Ofek, Richardson, and
Whitelaw (2004) study a limited sample period of 118 days, from July 1999 to November
2001, and demonstrate that higher rebate rates are associated with severe violations of put-
call parity, which indicates higher demand for put options. Ni and Pan (2011) find that
higher put-call volume ratios predict more negative subsequent returns for prohibited
stocks during the 2008 Short-Sale Ban period, which suggests that investors trade puts
when short selling is unavailable. Similarly, Johnson and So (2012) and Blau and Wade
(2013) show that options trading volume predicts more negative stock returns when short-
sale costs increase.
2.2 Short Selling As a Hedging Instrument for Put Options Market

Makers—Supply-Side Channel
Figlewski and Webb (1993) show that short interest increases near options listing dates
and argue that options market makers must hedge the risk of writing puts through short
selling. Similarly, Delisle, Lee, and Mauck (2012) find a significant positive correlation be-
tween short interest and options open interest. Danielsen and Sorescu (2001) find
higher short interest and lower abnormal stock returns near options listing dates, which is
consistent with the argument that options could encourage short selling and mitigate short-
sale constraints. Evans et al. (2009) show that options market makers use equity loans to
hedge against the risk of providing synthetic short positions. Blau (2013) shows that the
predictability of short-sale volume on stock returns is stronger after the introduction of
options.
In addition, two papers on the 2008 Short-Sale Ban show that the ban cannot be
circumvented through options trading. Both papers conjecture that this inability to circum-
vent the ban is due to increased hedging costs faced by options market makers during the
ban. Battalio and Schultz (2011) find that the ban significantly increases the options
bid-ask spread for banned stocks, whereas Grundy, Lim, and Verwijmeren (2012)
show sizeable decreases in put options trading volume for banned stocks during the ban
period.2
In sum, the previous literature, which tends to focus on just one channel, does not pro-
vide a comprehensive analysis of how the interaction between the two markets is affected
by the two distinct demands in the equity lending market. By using daily equity lending
transactions and the 2008 Short-Sale Ban, we provide compelling evidence that incorpor-
ates the two streams of the literature into one framework.
3. Data and Descriptive Statistics

We obtain a proprietary dataset for the US equity lending market from Data Explorers
(which was acquired by Markit on April 2, 2012). The dataset covers approximately 85%
of daily over-the-counter stock loan transactions from January 2007 to December 2011. It
contains detailed daily stock loan information, including rebate rates, short interest, total
loan values, and other relevant information. The options data are provided by
OptionMetrics, which is a comprehensive database providing end-of-day bid and ask
quotes, trading volumes, open interest, and other information for all options on US listed
equities. The stock trading data are from the Center for Research in Security Prices. The
general accounting data are provided by Compustat.
Following Grundy, Lim, and Verwijmeren (2012) and Johnson and So (2012), we apply
a set of data filters to alleviate the influence of illiquid options and exclude possible record-
ing errors. We exclude observations if (i) the underlying stock’s price is less than $5; (ii) the
option’s best closing bid is less than the intrinsic value; (iii) the option’s best closing ask is
less than the best closing bid; (iv) the time to the option’s expiration date is less than 30 or
more than 365 days; (v) the open interest is zero; (vi) the options bid-ask spread is greater
than 0.5; and (vii) each option contract has less than 50 non-zero trading records in the en-
tire sample. For the equity lending data, we exclude stock loan transactions within a five-
day window of the ex-dividend dates for dividend-paying stocks to address the concern that
stock lending is motivated by tax arbitrage.
The short-sale cost is measured by the equity lending fee, which is defined as the value-
weighted difference between the risk-free interest rate and the rebate rate, according to
Saffi and Sigurdsson (2011). The rebate rate is the rate paid for cash collateral required for
short selling. If one stock has multiple loan transactions on one day, the loan value is used
as the weight for each transaction. For stock i on day t, which has N equity lending transac-
tions, the lending fee is calculated as:
2 3
Ni;t 6
X 7
6 Loan valuen;i;t 7
Lending feei;t ¼ 6 ðRiskfree rate Rebate rate Þ 7; (1)
6XNi;t t n;i;t 7
n¼1 4 5
Loan valuen;i;t
n¼1
where n denotes the loan transaction, Riskfree ratet is the daily US Federal Funds Rate, and
Loan valuen;i;t is the total value of the stock on loan. To alleviate the influence of extreme
values, we truncate the equity lending fee data at the 0.5% level in each tail.
2 However, Mayhew and Mihov (2005) and Chan, Hung, and Ni (2012) find an insignificant relationship
between the options market and the equity lending market.
Based on Roll, Schwartz, and Subrahmanyam (2010), the put options trading volume is
proxied by the P/S ratio, which is the natural logarithm of the daily aggregated put options
trading volume relative to the stock trading volume. For stock i on day t, on which N differ-
ent put contracts are traded, the P/S ratio is calculated as:
0 Ni;t 1
X
B 100 Put volumen;i;t C
B n¼1 C
LnðP=SÞi;t ¼ LnB
B
C;
C (2)
@ Stock volume i;t A

where each option contract is multiplied by 100 to obtain the share volume. We take the
natural logarithm to diminish the effects of outliers. The put options trading cost is meas-
ured by the put bid-ask spread, which is the highest closing bid less the lowest closing ask
divided by the midpoint.
Panel A of Table I shows the descriptive statistics for the equity lending fee. The mean
equity lending fee is 0.897%, and this variable is volatile across the sample, with a standard
deviation of 3.822%. The put options trading volume and put options bid-ask spreads are
displayed in Panel B and Panel C. The mean value of the put options trading volume, meas-
ured by LnðP=SÞi;t , is 5.985, and the standard deviation is 1.777. The average bid-ask
spread of put options is 0.037, and the standard deviation is 0.032.
4. How Do Equity Lending Fees Affect Put Options Trading?

In this section, we test the following two hypotheses to shed light on the relationship be-
tween equity short selling and put options trading. First, when equity lending fees in-
crease, what happens to the put options trading volume and put options bid-ask spreads?
Second, when the demand for stock loans is solely driven by options market makers dur-
ing the 2008 Short-Sale Ban, does the relationship between short-sale costs and put op-
tions trading volume change? The detailed empirical setup is outlined in the following
subsections.
4.1 Overall Relationship Between Short-Sale Costs and Put Options Trading
There are two channels through which short-sale costs can affect put options trading. First,
from the perspective of the demand for options, when short-sale costs increase, speculative
short sellers might migrate to the options market to establish synthetic short positions by
buying puts. If so, ceteris paribus, we should observe a positive relationship between short-
sale costs and both the put options trading volume and put options bid-ask spreads.3 This is
because when the demand for put options shifts outward, the volume and the price of put
options would both increase, other things being equal. Put options market makers may in-
crease the bid-ask spread due to higher inventory risk and information asymmetry risk.
Under this scenario, short sales and put options can be viewed as substitutes for one
another.
Second, from the perspective of the supply of options, high short-sale costs will reduce
the market making of put options because short selling is necessary for put options market
3 We also find a similar pattern when we use implied volatility of put options as the price measure in
Section 5.1.
Table I. Descriptive statistics for equity short selling and put options trading
This table reports summary statistics for data on equity short selling and put options trading by
calendar year. The equity lending data are provided by Data Explorers. The put options trading
data are obtained from OptionMetrics. The sample period is from January 2007 to December
2011. The equity lending fee is defined as the difference between the risk-free rate and the re-
bate rate, expressed as a percentage. For stocks with multiple loan transactions on one day, the
loan value is used as the weight for each transaction. The put options trading volume is meas-
ured by the daily aggregated put to stock trading volume (P/S ratio), and the natural logarithm
is used to diminish the effects of outliers. The put bid-ask spread is calculated as the highest

closing bid less the lowest closing ask divided by the midpoint. Firm is the number of firms
included. Std is the cross-sectional standard deviation.
Year Firm 25% Median 75% Mean Std
Panel A: Equity lending fee (%)

2007 3,176 0.125 0.197 0.272 0.410 1.157
2008 2,617 0.028 0.183 0.346 0.944 3.676
2009 3,367 0.117 0.205 0.268 0.689 3.461
2010 4,320 0.227 0.280 0.373 0.875 3.876
2011 4,415 0.228 0.264 0.353 1.431 6.204
All 6,554 0.146 0.227 0.325 0.897 3.822
Panel B: Ln (P/S) ratio
2007 939 6.743 5.568 4.458 5.625 1.744
2008 860 7.079 5.845 4.732 5.946 1.783
2009 779 7.295 6.043 4.947 6.182 1.761
2010 776 7.272 6.015 4.890 6.133 1.766
2011 669 7.235 5.902 4.726 6.037 1.830
All 1,357 7.125 5.875 4.751 5.985 1.777
Panel C: Put bid-ask spread
2007 939 0.024 0.038 0.055 0.045 0.032
2008 860 0.021 0.034 0.053 0.042 0.032
2009 779 0.016 0.027 0.045 0.035 0.027
2010 776 0.015 0.022 0.035 0.033 0.034
2011 669 0.014 0.020 0.032 0.031 0.036
All 1,357 0.018 0.028 0.044 0.037 0.032
makers to hedge the risk of options market making. In this case, short-sale costs are posi-
tively correlated with put options bid-ask spreads but negatively correlated with the put op-
tions trading volume. Although both channels predict a positive correlation between short-
sale costs and put options bid-ask spreads, the implication of higher short-sale costs for put
options trading volume is ambiguous.
Our first hypothesis is that equity short selling and put options trading are substitutes
for one another in general, as traders can choose both venues to capitalize on their negative
private information or to hedge their long positions in stocks. As long as the size of the pos-
itions of these traders is larger than that of put option market makers, we expect equity
lending fees to be positively correlated with the P/S ratio and put options bid-ask spreads.
This expectation indicates that the outward shift of the put options demand curve caused
by higher short-sale costs is greater than the inward shift of the put options supply curve.
To test this conjecture, we perform the following two pooled OLS regressions:
LnðP=SÞi;t ¼ b0 þ b1 Lending feei;t þ b2 LnðSizeÞi;m1 þ b3 B=Mi;y1 þ b4 Stockbaspi;t

þ b5 Lagreturni;m1 þ b6 Volatilityi;m1 þ b7 Skewnessi;m1 þ b8 IORi;q1
(3)
þ b9 VIXt þ b10 Market returnt þ b11 Stockreti;t þ dYear fixed effects
þ cIndustry fixed effects þ ei;t ;
Putbaspj;i;t ¼ b0 þ b1 Lending feei;t þ b2 Dj;i;t Moneynessj;i;t þ b3 ½Dj;i;t Moneynessj;i;t 2

þ b4 ð1 Dj;i;t Þ Moneynessj;i;t þ b5 ½ð1 Dj;i;t Þ Moneynessj;i;t 2
þ b6 ðMaturityj;i;t Þ1 þ b7 Stockvoli;t þ b8 LnðSizeÞi;m1 þ b9 B=Mi;y1

þ b10 Stockbaspi;t þ b11 Lagreturni;m1 þ b12 Volatilityi;m1
þ b13 Skewnessi;m1 þ b14 IORi;q1 þ b15 VIXt þ b16 Market returnt
þ b17 Stockreti;t þ dYear fixed effects þ cIndustry fixed effect þ ej;i;t :
(4)
In Equation (3), we regress the P/S ratio on the equity lending fee. The control variables in-
clude a series of firm-level characteristics and market-level conditions, that is, the natural
logarithm of firm size at the end of the last calendar month, LnðSizeÞi;m1 ; the book-to-
market ratio at the end of the last calendar year, B=Mi;y1 ; the stock bid-ask spread, defined
as the closing ask less the closing bid, divided by the midpoint, Stockbaspi;t ; the daily stock
return, Stockreti;t ; the cumulative stock return over the last month, Lagreturni;m1 ; stock re-
turn volatility in the previous month, Volatilityi;m1 ; the skewness of daily stock returns in
the previous month, Skewnessi;m1 ; the institutional ownership ratio, IORi;q1 , which is
defined as institutional holdings divided by the total number of shares outstanding at the
last quarter end; market uncertainty, proxied by VIXt ; and the market return, measured by
the return on the S&P 500 Index.
In Equation ð4Þ, the put options bid-ask spread is regressed on the equity lending fee.
Following Grundy, Lim, and Verwijmeren (2012), we control for various option-level
characteristics. Dj;t is a dummy variable that equals 1 if the option strike price is no
greater than the underlying stock price q and 0 otherwise.
ffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
ffi Moneynessj;i;t is defined as
LnðStock pricei;t =Strike pricej;i;t Þ=ðIVATM Maturityj;i;t Þ, where IVATM is the implied
volatility of the closest-to-the-money put options on the same stock with an identical ob-
servation date and expiration date. This variable describes how much a put option is in or
out of the money. Maturityj;i;t is the number of days to the put option’s expiration date.
In addition, we control for the daily stock volume, Stockvoli;t , while retaining the
same firm-level and market-level explanatory variables that we use in Equation ð3Þ. In
both regressions, year fixed effects and Fama–French twelve industry fixed effects are
also included. The estimated standard errors are double clustered by firm and calendar
year.
We anticipate positive coefficients on Lending feei;t in both Equations ð3Þ and ð4Þ. Such
a finding would suggest that an increase in short-sale costs is accompanied by increases in
both the put options trading volume and the put options bid-ask spread. We expect the in-
fluence of a higher equity lending fee on options market makers to be dominated by the im-
pact on informed investors or hedgers.
Table II presents the estimated coefficients for Equation ð3Þ, where the P/S ratio is the
dependent variable. Without adding any control variables, the equity lending fee is posi-
tively correlated with the P/S ratio (t-statistic ¼ 6.64), as shown in the first column. The
positive relationship between short-sale costs and put options trading volume remains stat-
istically significant after we control for firm characteristics, market conditions, year fixed
effects, and Fama–French twelve industry fixed effects. The last column shows that when
all control variables are included, the lending fee remains positively associated with the P/S
ratio, with a coefficient of 0.053 (t-statistic ¼ 6.44). A one-standard-deviation increase in
the equity lending fee is associated with a 0.11-standard-deviation increase in the P/S ratio.
These results suggest that when short-sale costs increase, investors shift their demand from

the lending market to the options market, where it is relatively cheaper to buy put options.
When regressing the put options bid-ask spread on the equity lending fee, as seen in the
first column of Table III, we observe that higher short-sale costs raise the put options bid-
ask spread (t-statistic ¼ 6.44). In the last column, the coefficient on the lending fee remains
positive and statistically significant (t-statistic ¼ 3.93) after we control for the put contract
characteristics, firm characteristics, market conditions, year fixed effects, and industry fixed
effects. A one-standard-deviation increase in the equity lending fee is accompanied by a
5.37-standard-deviations increase in the put options bid-ask spread. The positive correl-
ation between short-sale costs and the put options transaction suggests that investors with
negative private information or with a long position to hedge turn to the options market to
trade put options when equity lending fees increase.
Combining the results in Tables II and III, we conclude that when short selling becomes
more expensive, informed traders wishing to sell short trade put options instead. Although
options market makers need to hedge their short positions in put options by selling short
the underlying stocks, the influence of short-sale costs on put options trading is dominated
by the demand-side channel.
4.2 Disentangling the Speculative Demand from Hedging Demand in

the Equity Lending Market
In the second hypothesis, we test whether the positive relationship between short-sale costs
and put options trading reverses when the demand for short selling is only from options
market makers hedging the risk of issuing puts. We use the 2008 Short-Sale Ban to tease
out the speculative demand of informed traders in the equity lending market.
In September 2008, the SEC issued a Short-Sale Ban prohibiting short selling on nearly
1,000 US listed firms to prevent short selling from being used to drive down the share prices
of issuers even where there is no fundamental basis for a price decline.4 The ban was in ef-
fect from September 19, 2008, to October 8, 2008. A limited exemption was granted by the
SEC to options market makers when selling short as part of bona fide market making and
hedging activities related directly to bona fide market making in derivatives.5 With respect
to banned stocks during the ban period, other investors could no longer take short pos-
itions. Meanwhile, the elimination of the option market maker exception in Regulation
SHO might increase the demand of option market makers in the equity lending market be-
cause they must deliver shares sold short on time when hedging (Stratman and Welborn,
2013). Thus, short-sale costs could only influence the hedging demand of options market
4 See SEC Emergency Order (34-58592).

5 See SEC Emergency Order (34-58592).
Table II. How do short-sale costs influence put options trading volume?
In this table, we present the pooled OLS results of a regression of the P/S ratio on the equity
lending fee. The dependent variable is the natural logarithm of the daily aggregated trading vol-
ume of put options scaled by the stock trading volume. Lending fee is defined as the difference
between the risk-free rate and the rebate rate, expressed as a percentage. Ln(Size) is the natural
logarithm of firm size at the end of the last calendar month. B/M ratio is the book-to-market ratio
at the end of the last calendar year. Stock bid-ask spread is defined as the closing ask less the
closing bid divided by the midpoint. Last month stock return is the cumulative stock return over
the last month. Stock return volatility is calculated using the daily return in the previous month.
Historical return skewness is the skewness of daily stock returns over the previous month.

Institutional holding ratio is defined as institutional holdings divided by the total number of
shares outstanding at the last quarter end. VIX is the daily VIX index value. S&P 500 index re-
turn is the daily return of the S&P 500 index. Stock return is the daily stock return. Industry FE
and Year FE refer to controls for Fama–French twelve industry fixed effects and year fixed ef-
fects, respectively. Estimated standard errors are double clustered by firm and calendar year.
***, **, and * indicate that the estimated coefficient is significant at the 1%, 5%, and 10% level,
respectively.
Dependent variable: Ln(put volume/stock volume)
Intercept 6.086*** 6.086*** 12.778*** 12.521***

(97.91) (98.38) (17.46) (15.41)
Lending fee 0.025*** 0.025*** 0.054*** 0.053***
(6.64) (6.65) (6.24) (6.44)
Ln(Size) 0.298*** 0.301***
(9.55) (9.22)
B/M ratio 0.086 0.000
(1.06) (0.01)
Stock bid-ask spread 0.022 0.013
(0.64) (0.46)
Last month stock return 0.057 0.069
(0.27) (0.29)
Stock return volatility 4.444* 1.693
(1.74) (0.82)
Historical return skewness 0.016 0.014
(1.31) (1.30)
Institutional holding ratio 0.060 0.074
(0.23) (0.29)
VIX 1.729*** 1.592***
(6.91) (6.10)
S&P500 index return 0.161 1.661*** 1.464***
(0.37) (6.76) (6.14)
Stock return 1.288*** 1.166*** 1.157***
(4.07) (2.86) (2.78)
Industry FE No No No Yes
Year FE No No No Yes
N 259,834 259,834 226,381 226,381
Adj-R2 (%) 0.29 0.35 6.06 7.57
Table III. How do short-sale costs influence put options bid-ask spreads?
In this table, we present the pooled OLS results of a regression of the bid-ask spread of put op-
tions on the equity lending fee of the underlying stock. The dependent variable is the put options
bid-ask spread. Lending fee is defined as the difference between the risk-free rate and the rebate
rate, expressed as a percentage. Dummy is a dummy variable that indicates whether the option
strike price is no greater than the stock price. Moneyness describes how much a put option is in
or out of the money. Time to maturity is the number of days to the put option’s expiration date.
Stock volume is the daily stock trading volume. Ln(Size) is the natural logarithm of firm size at the
end of the last calendar month. B/M ratio is the book-to-market ratio at the end of the last calendar
year. Stock bid-ask spread is defined as the closing ask less the closing bid divided by the mid-

point. Last month stock return is the cumulative stock return over the last month. Stock return
volatility is calculated using the daily return in the previous month. Historical return skewness is
the skewness of daily stock returns in the previous month. Institutional holding ratio is defined as
institutional holdings divided by the total number of shares outstanding at the last quarter end.
VIX is the daily VIX index value. S&P 500 index return is the daily return of the S&P 500 index.
Stock return is the daily stock return. Industry FE and year FE refer to controls for Fama–French
twelve industry fixed effects and year fixed effects, respectively. Estimated standard errors are
double clustered by firm and calendar year. ***, **, and * indicate that the estimated coefficient
is significant at the 1%, 5%, and 10% level, respectively.
Dependent variable: Put bid-ask spread
Intercept 2.869*** 3.111*** 19.166*** 22.623*** 22.615***

(11.35) (11.26) (12.82) (22.20) (22.26)
Lending fee 0.102*** 0.101*** 0.040*** 0.045*** 0.045***
(11.10) (11.33) (3.67) (3.94) (3.93)
Dummy * moneyness 33.810*** 41.317*** 44.172*** 44.157***
(5.30) (6.11) (7.49) (7.40)
(Dummy * moneyness)2 312.830*** 315.585*** 339.768*** 339.527***
(6.14) (4.95) (6.08) (6.05)
(1–Dummy) * moneyness 39.700*** 40.873*** 39.604*** 39.602***
(6.34) (4.69) (4.79) (4.77)
[(1–Dummy) * moneyness]2 21.209 34.923 89.564 89.731
(0.78) (0.55) (1.36) (1.36)
1/(time to maturity) 38.229*** 36.515*** 35.302*** 35.328***
(4.36) (3.44) (3.69) (3.68)
Stock volume 0.002 0.002* 0.002*
(1.55) (1.78) (1.77)
Ln(Size) 0.666*** 0.822*** 0.822***
(9.95) (18.47) (18.59)
B/M ratio 0.066 0.207** 0.207**
(0.55) (2.19) (2.19)
Stock bid-ask spread 0.956** 0.592*** 0.593***
(2.43) (4.95) (4.96)
Last month stock return 0.693* 0.358*** 0.367***
(1.73) (6.77) (5.51)
Stock return volatility 8.783 17.396*** 17.285***
(1.42) (4.87) (4.81)
Historical return skewness 0.061 0.006 0.007
(1.52) (0.61) (0.65)
(continued)
Table III. Continued

Institutional 0.860* 1.312*** 1.313***

ownership ratio
(1.83) (4.24) (4.24)
VIX 2.638*** 2.494*** 2.456***
(3.43) (5.12) (5.36)
S&P 500 index 1.785
return (1.55)
Stock return 0.692

(1.57)
Industry FE No No No Yes Yes
Year FE No No No Yes Yes
N 1,574,136 1,566,205 1,317,558 1,317,558 1,317,558
Adj-R2 (%) 1.95 10.96 24.97 34.39 34.40
makers. In this way, the 2008 Short-Sale Ban provides a relatively clean test of the relation-
ship between short selling and put options via the supply-side channel only.
We obtain information on stocks subjected to the Ban from SEC Emergency Order (34-
58592). We introduce a dummy variable that indicates banned stocks during the banned
period and its interaction with the equity lending fee into the previous regressions:
LnðP=SÞi;t ¼ b0 þ b1 Lending feei;t þ b2 Lending feei;t Bannedi;t

þ b3 Bannedi;t þ b4 LnðSizeÞi;m1 þ b5 B=Mi;y1 þ b6 Stockbaspi;t
þ b7 Lagreturni;m1 þ b8 Volatilityi;m1 þ b9 Skewnessi;m1 þ b10 IORi;q1 (5)
þ cIndustry fixed effects þ ei;t :
Putbaspj;i;t ¼ b0 þ b1 Lending feei;t þ b2 Lending feei;t Bannedi;t
þ b3 Bannedi;t þ b4 Dj;i;t Moneynessj;i;t þ b5 ½Dj;i;t Moneynessj;i;t 2
þ b8 ðMaturityj;i;t Þ1 þ b9 Stockvoli;t þ b10 LnðSizeÞi;m1 þ b11 B=Mi;y1 (6)

þ b19 Stockreti;t þ dYear fixed effects þ cIndustry fixed effects þ ei;t :
The dummy variable Bannedi;t equals 1 when firm i is on the banned list and day t is
within the 2008 Short-Sale Ban period and 0 otherwise. Because only options market mak-
ers could take short positions in banned stocks during the banned period, the coefficients
on the interaction term in both Equation ð5Þ and Equation ð6Þ indicate the incremental pro-
portion of the impact of the equity lending fee on put options trading volume and bid-ask
spreads related only to the hedging activities of options market makers.
In the two regressions, the coefficients on the equity lending fee represent the influence
of short-sale costs on put options trading volume and put options bid-ask spreads for non-
banned cases. We expect positive values for b1 in both Equations ð5Þ and ð6Þ, illustrating a
substitutive relationship between short selling and put options trading. We are particularly
interested in the interaction coefficient, b2 , in Equation ð5Þ, where the P/S ratio is the de-
pendent variable. Specifically, we expect a significantly negative value for ðb1 þ b2 Þ in
Equation ð5Þ, which indicates a negative correlation between the stock lending fee and put
options trading volume for banned stocks during the banned period when options market
makers are the only short sellers. When short-sale costs increase, options market makers
are discouraged from writing puts due to higher hedging costs of issuing put options. A
brief summary of the intuition behind the empirical design is presented in Appendix A.
The estimated coefficients for Equation ð5Þ are presented in Table IV. When the Ban is
not in effect, that is, when both options market makers and informed traders can sell short,

we find that higher short-sale costs are associated with a larger trading volume of put op-
tions. In the last column, the equity lending fee has a significantly positive coefficient of
0.053 (t-statistic ¼ 6.42), which is consistent with the findings for the first hypothesis that,
without disentangling the short-sale demand of informed traders from that of options mar-
ket makers, put options and short sales appear to be substitutes. The interaction term has a
significantly negative coefficient (t-statistic ¼ –10.43). More importantly, the value of
ðb1 þ b2 Þ is negative (0.053–0.114 ¼ 0.061 with the p-value of the F-test < 0.000), which
is consistent with the expectation that higher short-sale costs reduce put options market
making and trading volume. During the 2008 Short-Sale Ban, an increase in the equity lend-
ing fee decreases the put options trading volume for stocks subject to the ban.
The coefficient on the banned dummy variable becomes insignificant when we add its
interaction with the equity lending fee to the regression. This is an important result, as the
dummy variable may capture the endogenous characteristics of stocks subjected to the
Short-Sale Ban and the deteriorated macro-economic situation for financial stocks during
the banned period, for example, increased stock spreads, increased information asymme-
tries, an increased pricing power for market makers who alone could hedge long exposure
to financial stocks by short-selling stocks, and an increased policy uncertainty faced by
market participants. It also highlights the importance of including the lending fee to con-
duct a thorough analysis of how the two markets interact with each other.
As for the put options bid-ask spread, we show in the last column of Table V that for the
non-banned period or non-banned stocks during the banned period, a higher equity lending
fee is accompanied by an increase in the put options bid-ask spread, with all control variables
included. The coefficient on the equity lending fee is significantly positive (t-statistic ¼ 4.00).
This finding lends support to the first hypothesis: when short sellers include both traders and
options market makers, higher short-sale costs provide traders with stronger incentives to
buy put options. The shifted demand from short selling to put options increases the bid-ask
spreads of put options. The interaction term has a positively significant coefficient of 0.532,
which indicates that the positive association between equity lending fees and put options bid-
ask spreads is much stronger for the banned stocks during the banned period.
We also observe a significantly positive coefficient on the dummy variable, Bannedi;t ,
which indicates that the Short-Sale Ban itself is associated with increased put options trans-
action costs. This finding is consistent with the findings of Battalio and Schultz (2011) and
Grundy, Lim, and Verwijmeren (2012) and can be attributed to uncertainty in the market
due to the regulatory change.
In sum, we exploit the 2008 Short-Sale Ban to tease out the demand-side channel
through which short-sale costs can affect the venue choice of informed traders. We provide
direct evidence that the “complementarity” found in the literature (e.g., Delisle, Lee, and
Table IV. Short-sale costs and put options trading volume during the 2008 Short-Sale Ban
This table shows the pooled OLS results of a regression of the P/S ratio on the equity lending
fee and its interaction with the 2008 Short-Sale Ban dummy variable. The dependent variable is
the natural logarithm of the daily aggregated trading volume of put options scaled by the stock
trading volume. Lending fee is defined as the difference between the risk-free rate and the re-
bate rate, expressed as a percentage. Banned dummy is a dummy variable indicating banned
stocks in the banned period. Ln(Size) is the natural logarithm of firm size at the end of the last
calendar month. B/M ratio is the book-to-market ratio at the end of the last calendar year. Stock
bid-ask spread is defined as the closing ask less the closing bid divided by the midpoint. Last
month stock return is the cumulative stock return over the last month. Stock return volatility is

calculated using the daily return in the previous month. Historical return skewness is the skew-
ness of daily stock returns in the previous month. Institutional holding ratio is defined as institu-
tional holdings divided by the total number of shares outstanding at the last quarter end. VIX is
the daily VIX index value. S&P 500 index return is the daily return of the S&P 500 index. Stock
return is the daily stock return. Industry FE and year FE refer to controls for Fama–French twelve
industry fixed effects and year fixed effects, respectively. Estimated standard errors are double
clustered by firm and calendar year. ***, **, and * indicate that the estimated coefficient is sig-
nificant at the 1%, 5%, and 10% level, respectively.
Dependent variable: Ln(put volume/stock volume)
Intercept 6.086*** 6.086*** 12.781*** 12.520***

(97.77) (98.24) (17.45) (15.41)
Lending fee 0.025*** 0.025*** 0.054*** 0.053***
(6.60) (6.61) (6.22) (6.42)
Lending fee * banned dummy 0.145*** 0.160*** 0.127*** 0.114***
(30.88) (57.55) (10.91) (10.43)
Banned dummy 0.105** 0.132*** 0.093 0.021
(2.47) (3.05) (1.06) (0.23)
Ln(Size) 0.298*** 0.301***
(9.54) (9.21)
B/M ratio 0.086 0.001
(1.07) (0.01)
Stock bid-ask spread 0.024 0.014
(0.67) (0.49)
Last month return 0.059 0.070
(0.27) (0.29)
Stock return volatility 4.470* 1.693
(1.74) (0.81)
(1.30) (1.30)
Institutional holding ratio 0.060 0.074
(0.23) (0.29)
VIX 1.729*** 1.592***
(6.90) (6.10)
S&P 500 index return 0.180 1.675*** 1.468***
(0.41) (6.68) (6.16)
Stock return 1.290*** 1.169*** 1.159***
(4.09) (2.88) (2.79)
Industry FE No No No Yes
Year FE No No No Yes
p-value of F-test for b1 þ b2 ¼ 0 <0.000 <0.000 <0.000 <0.000
N 259,834 259,834 226,381 226,381
Adj-R2 (%) 0.29 0.35 6.06 7.58
Table V. Short-sale costs and put options bid-ask spreads during the 2008 Short-Sale Ban
This table shows the pooled OLS results of a regression of the bid-ask spread of put options on
the equity lending fee and its interaction with the 2008 Short-Sale Ban dummy variable. The de-
pendent variable is the put options bid-ask spread. Lending fee is defined as the difference be-
tween the risk-free rate and the rebate rate, expressed as a percentage. Banned dummy is a
dummy variable indicating banned stocks in the banned period. Dummy is a dummy variable
that indicates whether the option strike price is no greater than the stock price. Moneyness de-
scribes how much a put option is in or out of the money. Time to maturity is the number of days
to the put option’s expiration date. Stock volume is the daily stock trading volume. Ln(Size) is
the natural logarithm of firm size at the end of the last calendar month. B/M ratio is the book-to-
market ratio at the end of the last calendar year. Stock bid-ask spread is defined as the closing ask

less the closing bid and divided by the midpoint. Last month stock return is the cumulative stock
return over the last month. Stock return volatility is calculated using the daily return in the previ-
ous month. Historical return skewness is the skewness of daily stock returns in the previous
month. Institutional holding ratio is defined as institutional holdings divided by the total number
of shares outstanding at the last quarter end. VIX is the daily VIX index value. S&P 500 index re-
turn is the daily return of the S&P 500 index. Stock return is the daily stock return. Industry FE and
year FE refer to controls for Fama–French twelve industry fixed effects and year fixed effects, re-
spectively. Estimated standard errors are double clustered by firm and calendar year. ***, **, and
* indicate that the estimated coefficient is significant at the 1%, 5%, and 10% level, respectively.
Intercept 2.862*** 3.104*** 19.400*** 22.763*** 22.759***

(11.57) (11.45) (13.67) (22.12) (22.21)
Lending fee 0.103*** 0.102*** 0.041*** 0.046*** 0.046***
(11.21) (11.51) (3.75) (4.00) (4.00)
Lending fee * banned dummy 0.626*** 0.574*** 0.550*** 0.533*** 0.532***
(37.35) (37.97) (20.80) (21.74) (23.58)
Banned dummy 6.909*** 6.661*** 6.595*** 5.794*** 5.787***
(34.45) (24.21) (19.38) (45.58) (43.92)
Dummy * moneyness 33.626*** 41.035*** 43.957*** 43.917***
(5.38) (6.22) (7.64) (7.56)
(Dummy * moneyness)2 310.736*** 312.999*** 337.872*** 337.439***
(6.34) (5.10) (6.26) (6.24)
(1–Dummy) * moneyness 39.518*** 40.514*** 39.320*** 39.298***
(6.45) (4.76) (4.86) (4.84)
[(1–Dummy) * moneyness]2 21.931 33.729 87.593 87.667
(0.80) (0.53) (1.34) (1.34)
1/(time to maturity) 38.042*** 36.130*** 35.023*** 35.029***
(4.43) (3.49) (3.74) (3.73)
Stock volume 0.002* 0.002* 0.002*
(1.65) (1.84) (1.83)
Ln(Size) 0.675*** 0.827*** 0.827***
(10.51) (18.29) (18.42)
B/M ratio 0.065 0.202** 0.202**
(0.55) (2.10) (2.09)
Stock bid-ask spread 0.901** 0.548*** 0.548***
(2.30) (4.43) (4.43)
Last month stock return 0.716* 0.398*** 0.401***
(1.68) (4.39) (4.05)
Stock return volatility 10.071* 18.268*** 18.216***
(1.84) (5.17) (5.16)
(continued)
Table V. Continued
Historical return skewness 0.066 0.012 0.012

(1.45) (0.90) (0.90)
Institutional holding ratio 0.856* 1.305*** 1.305***
(1.82) (4.20) (4.20)
VIX 2.656*** 2.486*** 2.464***
(3.43) (5.10) (5.29)
S&P500 index return 1.468
(1.59)

Stock return 0.723
(1.58)
Industry FE No No No Yes Yes
Year FE No No No Yes Yes
N 1,574,136 1,566,205 1,317,558 1,317,558 1,317,558
Adj-R2 (%) 2.76 11.70 25.83 35.05 35.05
Mauck, 2012) between put options and short sales is indeed due to the supply-side channel
of put options market makers.
5. Additional Tests and Robustness Checks

In this section, we perform additional tests and robustness checks to obtain further support-
ive evidence for our main hypotheses. First, we examine how equity lending fees affect the
implied volatilities of put options and whether the relationship changes for banned stocks
during the 2008 Short-Sale Ban period. Second, we investigate how lending fees influence
deviations from put-call parity and the implied volatility smirk. Third, we re-test the main
hypotheses using a 2SLS model to mitigate endogeneity concerns. Fourth, we use the ratio
P/(P þ C) as an alternative measure of put option trading volume. Finally, as a robustness
check, we conduct a sub-sample analysis of Equations (3) and (4), using only banned stocks
during the 2008 Short-Sale Ban period.
5.1 Short-Sale Costs and Put Options Implied Volatility

The implied volatility can be viewed as a measure of the price for trading put options. We
conduct a test to evaluate how short-sale costs affect the implied volatilities of put options.
In the previous section, we showed that higher short-sale costs increase investors’ demand
for put options. We therefore expect the implied volatility of put options to increase with
this excess demand. Pooled OLS regressions are performed as follows:
IVolj;i;t ¼ b0 þ b1 Lending feei;t þ b2 Dj;i;t Moneynessj;i;t þ b3 ½Dj;i;t Moneynessj;i;t 2

(7)
þ b17 Stockreti;t þ dYear fixed effects þ cIndustry fixed effect þ ej;i;t :
IVolj;i;t ¼ b0 þ b1 Lending feei;t þ b2 Lending feei;t Bannedi;t þ b3 Bannedi;t

þ b4 Dj;i;t Moneynessj;i;t þ b5 ½Dj;i;t Moneynessj;i;t 2 þ b6 ð1 Dj;i;t Þ
Moneynessj;i;t þ b7 ½ð1 Dj;i;t Þ Moneynessj;i;t 2 þ b8 ðMaturityj;i;t Þ1

þ b9 Stockvoli;t þ b10 LnðSizeÞi;m1 þ b11 B=Mi;y1 þ b12 Stockbaspi;t (8)

þ cIndustry fixed effect þ ej;i;t :

where IVolj;i;t is the implied volatility of put option j written on stock i on trading
day t.
The estimated results are presented in Table VI. The second column shows a signifi-
cantly positive correlation between short-sale costs and put options implied volatilities.
This finding is also in line with Evans et al. (2009), who use two years of data (1998 and
1999) from a large options market making firm. More importantly, as shown in the last
column, this positive correlation is much stronger for banned stocks during the banned
period (t-statistic ¼ 13.13). Overall, these results are consistent with the findings of the pre-
vious section that investors with negative private information trade more put options when
short selling is expensive.
5.2 How Are Short-Sale Costs Correlated With the Put-Call Parity Deviation
and the Implied Volatility Smirk?
In this subsection, we investigate how short-sale costs are correlated with the degree of put-
call parity deviation and the implied volatility smirk. Existing studies argue that put-call
parity deviations can arise due to short-sale constraints on the underlying stocks (e.g.,
Ofek, Richardson, and Whitelaw, 2004).6 The implied volatility smirk describes a well-
documented implied volatility pattern whereby out-of-the-money (OTM) options are typic-
ally more expensive than at-the-money (ATM) options.7 In our context, a higher stock
lending fee shifts investors’ demand to put options, which increases the implied volatility of
put options and thus affects the degree of put-call parity deviation and the implied volatility
smirk.
5.2.a Put-call parity deviation

Following Cremers and Weinbaum (2010), we measure deviations from put-call parity
using the IV Spread. This measure is defined as the difference in implied volatility between
matched pairs of calls and puts with the same strike prices and expiration dates. We use the
6 Previous studies demonstrate that deviations from put-call parity for American options are not ne-
cessarily arbitrage opportunities but are evidence of informed trading. See, for example, Ofek,
Richardson, and Whitelaw (2004); Bali and Hovakimian (2009); Cremers and Weinbaum (2010); Jin,
Livnat, and Zhang (2012); Chan, Ge, and Lin (2013); and Lin and Lu (2015).
7 Previous research relates the implied volatility smirk to informed options trading with respect to
various material nonpublic information. See, for example, Bates (1991); Bollen and Whaley (2004);
Xing, Zhang, and Zhao (2010); Jin, Livnat, and Zhang (2012); Chan, Ge, and Lin (2013); and Lin and Lu
(2015).
Table VI. Short-sale costs and put options implied volatility
This table displays the pooled OLS regression results with the put options implied volatility as
the dependent variable. The implied volatility of put options is expressed in percentages.
Lending fee is defined as the difference between the risk-free rate and the rebate rate, ex-
pressed as a percentage. Banned dummy is a dummy variable indicating banned stocks in the
banned period. Dummy is a dummy variable that indicates whether the option strike price is no
greater than the stock price. Moneyness describes how much a put option is in or out of the
money. Time to maturity is the number of days to the put option’s expiration date. Stock vol-
ume is the daily stock trading volume. Ln(Size) is the natural logarithm of firm size at the end of
the last calendar month. B/M ratio is the book-to-market ratio at the end of the last calendar

volatility is calculated using the daily return in the previous month. Historical return skewness
is the skewness of daily stock returns in the previous month. Institutional holding ratio is
defined as institutional holdings divided by the total number of shares outstanding at the last
quarter end. VIX is the daily VIX index value. S&P 500 index return is the daily return of the S&P
500 index. Stock return is the daily stock return. Industry FE and year FE refer to controls for
Fama–French twelve industry fixed effects and year fixed effects, respectively. Estimated stand-
ard errors are double clustered by firm and calendar year. ***, **, and * indicate that the esti-
mated coefficient is significant at the 1%, 5%, and 10% level, respectively.
Dependent variable: Put options implied volatility
Intercept 41.908*** 138.114*** 41.874*** 138.197***

(13.93) (16.00) (14.00) (15.96)
Lending fee 1.658*** 0.852*** 1.661*** 0.853***
(6.87) (13.14) (6.84) (13.13)
Lending fee * banned dummy 2.669*** 0.375*
(11.32) (1.89)
Banned dummy 34.404*** 3.350***
(12.06) (3.08)
Dummy * moneyness 5.036 4.597
(0.18) (0.16)
(Dummy * moneyness)2 4823.331* 4849.716*
(1.78) (1.77)
(1–Dummy) * moneyness 180.451*** 180.289***
(9.16) (9.22)
[(1–Dummy) * moneyness]2 2670.188*** 2669.111***
(7.37) (7.38)
1/(time to maturity) 14.122 13.952
(0.29) (0.29)
S&P500 return 1.472 1.656
(0.67) (0.71)
Stock return 15.404*** 15.384***
(13.36) (13.56)
Stock volume 0.042*** 0.042***
(4.91) (4.89)
Ln(Size) 4.753*** 4.756***
(13.78) (13.73)
B/M ratio 1.198** 1.202**
(continued)
Table VI. Continued

Dependent variable: Put options implied volatility
(2.23) (2.24)
Stock bid-ask spread 1.466* 1.441*
(1.95) (1.89)
Last month return 5.540** 5.560**
(2.47) (2.45)
Stock return volatility 529.214*** 528.675***
(29.15) (28.59)

(0.21) (0.20)
Institutional holding ratio 4.884* 4.879*
(1.69) (1.68)
VIX 25.523*** 25.528***
(9.35) (9.37)
Industry FE No Yes No Yes
Year FE No Yes No Yes
N 1,570,407 1,314,968 1,570,407 1,314,968
Adj-R2 (%) 8.65 81.22 9.00 81.22
mean open interest of option pairs as weights when there are multiple pairs for a single
stock on one trading day 8:
X i;put
IV spreadi;t ¼ wij;t ðIVoli;call
j;t IVolj;t Þ: (9)
j
We re-estimate the regressions in the previous section using the IV Spread as the depend-
ent variable:
IV Spreadi;t ¼ b0 þ b1 Lending feei;t þ b2 Market returnt þ b3 Stockreti;t þ b4 Stockvoli;t

þ b5 LnðSizeÞi;m1 þ b6 B=Mi;y1 þ b7 Stockbaspi;t þ b8 Lagreturni;m1
þ b9 Volatilityi;m1 þ b10 Skewnessi;m1 þ b11 IORi;q1 þ b12 VIXt
þ dYear fixed effects þ cIndustry fixed effects þ ei;t :
(10)
IV Spreadi;t ¼ b0 þ b1 Lending feei;t þ b2 Lending feei;t Bannedi;t þ b3 Bannedi;t
þ b4 Market returnt þ b5 Stockreti;t þ b6 Stockvoli;t þ b7 LnðSizeÞi;m1
þ b8 B=Mi;y1 þ b9 Stockbaspi;t þ b10 Lagreturni;m1 þ b11 Volatilityi;m1
þ b12 Skewnessi;m1 þ b13 IORi;q1 þ b14 VIXt þ dYear fixed effects
(11)
8 Because the equity options in our sample are American, even in a perfect capital market, the
implied volatility spread given by Equation (9) will not be zero. It will instead reflect the potential for
the early exercise of American put options and for the early exercise of American call options writ-
ten on dividend-paying stock. The level of the non-zero spread can be captured by the constant
term in Equations (10) and (11).
In the first column of Table VII, we find that firms with a higher equity lending fee have
a significantly lower IV Spread. Because short-sale costs increase the demand for put op-
tions, the implied volatility of put options increases, which results in a decrease in the
IV Spread. This result is also consistent with those of Ofek, Richardson, and Whitelaw
(2004) and Evans et al. (2009), both of whom show that short-sale costs are positively
related to violations of put-call parity, using data covering shorter periods (1999–2001 and
1998–99, respectively) and smaller sets of firms.
In the second column, we show that the negative correlation between the equity lending
fee and the IV Spread is more significant for banned stocks during the banned period. These
results are in line with the finding of Grundy, Lim, and Verwijmeren (2012) that financial

firms during the Short-Sale Ban period exhibit larger deviations from put-call parity. We
complement and extend their analysis by directly showing that the larger deviations can be
attributed to higher equity lending fees, not just the impact of the financial crisis on finan-
cial firms.
5.2.b. Implied volatility smirk

Similar to Xing, Zhang, and Zhao (2010), we quantify the implied volatility smirk as the
IV Skew, which is the difference in implied volatility between OTM put options and ATM
call options written on the same underlying stock9:
IV skewi;t ¼ IVolOTMP
i;t IVolATMC
i;t : (12)
We conduct the following regressions to assess the impact of the equity lending fee on
the IV Skew:
IV Skewi;t ¼ b0 þ b1 Lending feei;t þ b2 Market returnt þ b3 Stockreti;t þ b4 Stockvoli;t

(13)
IV Skewi;t ¼ b0 þ b1 Lending feei;t þ b2 Lending feei;t Bannedi;t þ b3 Bannedi;t

þ b8 B=Mi;y1 þ b9 Stockbaspi;t þ b10 Lagreturni;m1 þ b11 Volatilityi;m1 (14)
þ b12 Skewnessi;m1 þ b13 IORi;q1 þ b14 VIXt þ dYear fixed effects
In the third and fourth columns of Table VII, we observe that a higher equity lending fee
is associated with a larger IV Skew and that the positive correlation is significantly stronger
for banned stocks during the banned period. When short selling becomes more expensive,
investors with negative private information or with a long position to hedge prefer to buy
put options, particularly OTM put options. The implied volatility of OTM put options
then increases, leading to a higher IV Skew.
9 A put option is considered to be OTM if the ratio of the strike price to the stock price is between
0.80 and 0.95. A call option is ATM when the ratio is between 0.95 and 1.05. When there is more
than one record of OTM put options or ATM call options for one stock on one trading day, we use
the average open interest as a weight to calculate the weighted mean value.
Table VII. Short-sale costs, put-call parity, and implied volatility smirk
This table shows how short-sale costs affect the put-call parity and the implied volatility smirk.
IV spread is a measure of the deviation from put-call parity and is defined as the difference in
the implied volatility between matched pairs of calls and puts with the same strike prices and
expiration dates. IV skew quantifies the implied volatility smirk, which is the difference between
the implied volatility of the OTM put options and ATM call options that are written on the same
underlying stock. The IV spread and IV skew are both expressed as percentages. Lending fee is
defined as the difference between the risk-free rate and the rebate rate, expressed as a percent-
age. Banned dummy is a dummy variable indicating banned stocks in the banned period. Stock
volume is the daily stock trading volume. Ln(Size) is the natural logarithm of firm size at the

end of the last calendar month. B/M ratio is the book-to-market ratio at the end of the last calen-
dar year. Stock bid-ask spread is defined as the closing ask less the closing bid and divided by
the midpoint. Last month stock return is the cumulative stock return over the last month. Stock
return volatility is calculated by using the daily return in the previous month. Historical return
skewness is the skewness of daily stock returns in the previous month. Institutional holding
ratio is defined as institutional holdings divided by the total number of shares outstanding at
the last quarter end. VIX is the daily VIX index value. S&P 500 index return is the daily return of
the S&P 500 index. Stock return is the daily stock return. Industry FE and year FE refer to con-
trols for Fama–French twelve industry fixed effects and year fixed effects, respectively.
Estimated standard errors are double clustered by firm and calendar year. ***, **, and * indi-
cate that the estimated coefficient is significant at the 1%, 5%, and 10% level, respectively.
Dependent variables
IV spread IV skew
Intercept 2.090 2.094 2.740 2.657

(1.56) (1.57) (0.78) (0.75)
Lending fee 0.928*** 0.927*** 0.913*** 0.913***
(14.90) (15.04) (63.75) (62.75)
Lending fee * banned dummy 1.198*** 1.758***
(15.55) (26.93)
Banned dummy 0.438 3.558***
(0.11) (22.45)
S&P 500 index return 8.481*** 8.506*** 7.570*** 7.620***
(5.44) (5.42) (7.44) (7.22)
Stock return 7.399*** 7.416*** 12.035*** 12.450***
(7.03) (6.95) (6.27) (6.11)
Stock volume 0.005*** 0.005*** 0.160 0.158
(3.89) (3.89) (1.20) (1.18)
Ln(Size) 0.061 0.062 0.219 0.224
(1.57) (1.58) (1.53) (1.56)
B/M ratio 0.212 0.211 0.355* 0.368*
(0.99) (0.98) (1.89) (1.95)
Stock bid-ask spread 0.180** 0.180** 1.890*** 1.867***
(2.00) (1.97) (3.51) (3.60)
Last month return 1.464** 1.455** 33.301*** 32.588***
(2.12) (2.09) (6.31) (6.48)
Stock return volatility 17.552*** 17.575*** 0.104 0.099
(3.72) (3.73) (1.05) (1.07)
(continued)
Table VII. Continued

Dependent variables
IV spread IV skew
Historical return skewness 0.017 0.017 0.370 0.373

(0.59) (0.58) (0.52) (0.52)
Institutional holding ratio 0.268 0.268 2.080*** 2.090***
(0.51) (0.51) (3.04) (3.09)
VIX 0.904 0.905 0.006 0.006
(1.32) (1.32) (1.29) (1.35)

Industry FE Yes Yes Yes Yes
Year FE Yes Yes Yes Yes
N 208,782 208,782 41,307 41,307
Adj-R2 (%) 55.16 55.20 51.00 51.09
Collectively, the results in this subsection provide an updated analysis of and evidence
regarding the positive correlation between lending fees and excess demand for put options,
particularly OTM puts. During the Ban period, the high hedging costs faced by put options
market makers result in a high put options price, which also provides support for our se-
cond hypothesis.
5.3 2SLS Analyses

5.3.a. Simultaneous determination of put volume and bid-ask spreads
As noted by Grundy, Lim, and Verwijmeren (2012), one potential concern is that the results
might be driven by the simultaneous determination of the put options bid-ask spread and
the put options trading volume. Based on their framework, we use a 2SLS regression model
to address this issue. For the simultaneous equations analysis, we construct the P/S ratio
at the option level. The detailed construction of the 2SLS regressions is presented in
Appendix B.
The first two columns of Table VIII report the regression results for our first hypothesis.
With the fitted value of the put options bid-ask spread included, the equity lending fee re-
mains positively correlated with the P/S ratio (t-statistic ¼ 5.22). Similarly, after adding the
fitted value of the P/S ratio, a higher equity lending fee still implies a larger put options bid-
ask spread (t-statistic ¼ 16.50). To sum up, the substitutability between put options and
short selling is not driven by the simultaneous determination of the put options trading vol-
ume and the put options bid-ask spread.
For the second hypothesis, we also find qualitatively similar results when we use the
2SLS regression model. As shown in the third column, higher short-sale costs for banned
stocks during the banned period result in a significantly lower put options trading volume,
manifesting the “complementarity” between put options and short sales when only the
supply-side channel is at work.
5.3.b. Simultaneous determination of put volume, bid-ask spreads, and lending fees
In this subsection, we extend the previous 2SLS regression to mitigate the concern that
equity lending fees and put options trading proxies could be simultaneously determined.
We incorporate the equity lending fee into the 2SLS analysis, using the lendable share ratio
Table VIII. 2SLS for put volume and bid-ask spreads
Table VIII reports the estimated results for the 2SLS regression model used to mitigate the con-
cern that put volume and put bid-ask spreads are simultaneously determined. Ln(P/S) is the nat-
ural logarithm of the daily put to stock trading volume ratio. The put bid-ask spread is the highest
closing bid less the lowest closing ask divided by the midpoint. Lending fee is defined as the dif-
ference between the risk-free rate and the rebate rate, expressed as a percentage. Banned
dummy is a dummy variable indicating banned stocks in the banned period. Dummy is a dummy
variable that indicates whether the option strike price is no greater than the stock price.
Moneyness describes how much a put option is in or out of the money. Time to maturity is the
number of days to the put option’s expiration date. Stock volume is the daily stock trading vol-

ume. Ln(Size) is the natural logarithm of firm size at the end of the last calendar month. B/M ratio
is the book-to-market ratio at the end of the last calendar year. Stock bid-ask spread is defined as
the closing ask less the closing bid and divided by the midpoint. Last month stock return is the cu-
mulative stock return over the last month. Stock return volatility is calculated using the daily re-
turn in the previous month. Historical return skewness is the skewness of daily stock returns in
the previous month. Institutional holding ratio is defined as institutional holdings divided by the
total number of shares outstanding at the last quarter end. VIX is the daily VIX index value. S&P
500 index return is the daily return of the S&P 500 index. Stock return is the daily stock return. t-
Statistics are calculated by using the Huber–White heteroskedasticity-adjusted standard errors.
***, **, and * indicate that the estimated coefficient is significant at the 1%, 5%, and 10% level,
respectively.
H1 H2
Ln(P/S) Put bid-ask spread Ln(P/S) Put bid-ask spread
Intercept 20.180*** 19.232*** 20.510*** 18.957***

(190.57) (121.05) (190.75) (122.53)
Fitted Ln(P/S) 0.369*** 0.254***
(12.00) (8.44)
Fitted put bid-ask spread 0.962*** 0.968***
(215.72) (214.97)
Lending fee 0.005*** 0.021*** 0.004*** 0.026***
(5.22) (16.50) (4.24) (20.61)
(7.31) (9.02)
Banned dummy 5.419*** 6.098***
(67.26) (98.68)
Dummy * moneyness 40.723*** 40.338***
(48.70) (49.69)
(Dummy * moneyness)2 256.092*** 275.221***
(8.00) (8.85)
(1–Dummy) * moneyness 18.240*** 23.268***
(12.18) (15.88)
[(1–Dummy) * moneyness]2 103.554*** 76.711***
(9.50) (7.22)
1/(time to maturity) 9.116*** 18.502***
(3.47) (7.20)
S&P 500 index return 1.974*** 1.585***
(9.66) (7.76)
Stock return 2.357*** 2.400***
(continued)
Table VIII. Continued

H1 H2
Ln(P/S) Put bid-ask spread Ln(P/S) Put bid-ask spread
(22.87) (23.27)
Stock volume 0.002*** 0.002***
(20.04) (18.88)
Ln(Size) 0.406*** 0.560*** 0.418*** 0.584***
(108.22) (127.71) (109.72) (135.47)
B/M ratio 0.132*** 0.003 0.133*** 0.020***

(27.06) (0.41) (27.39) (3.24)
Stock bid-ask spread 0.752*** 0.832*** 0.710*** 0.791***
(57.46) (77.70) (54.40) (76.28)
Last month stock return 0.459*** 0.719*** 0.488*** 0.785***
(20.84) (35.78) (22.16) (40.09)
Stock return volatility 6.353*** 2.483*** 4.978*** 4.941***
(30.97) (8.31) (23.97) (16.68)
Historical return skewness 0.039*** 0.060*** 0.044*** 0.068***
(10.71) (19.86) (12.26) (23.39)
Institutional holding ratio 1.002*** 0.802*** 1.004*** 0.766***
(48.68) (43.09) (48.76) (42.34)
VIX 2.247*** 2.400*** 2.290*** 2.368***
(65.83) (80.79) (66.90) (82.03)
N 863,286 863,286
and the institutional ownership ratio as instrumental variables.10 The detailed model setup
is also presented in Appendix B.
As suggested in Table IX, we obtain similar results: the equity lending market and the put
options market are substitutes for one another in general when informed traders are allowed
to short. After employing the 2SLS regression model, both the put options trading volume
and put options bid-ask spreads still increase with the fitted value of equity lending fees.11
5.4 Short-Sale Costs and the Put-Call Ratio

As a robustness check, we use the ratio P/(P þ C) to measure the put options trading vol-
ume. Following Pan and Poteshman (2006), the ratio is constructed as follows:
Mi;t
X
Put volumem;i;t
m¼1
P=ðP þ CÞi;t ¼ Mi;t Ni;t
: (15)
X X
Put volumem;i;t þ Call volumen;i;t
m¼1 n¼1
10 D’Avolio (2002), Prado, Saffi, and Sturgess (2014), and Chang, Lin, and Ma (2014) all find that lend-
ing fees are significantly related to institutional ownership, as passive institutional investors such
as index funds and ETFs are the major lenders in the stock lending market.
11 Inclusion of the interaction between lending fees and the banned dummy in the 2SLS regression
is econometrically challenging and presents difficulties of interpretation. Therefore, we do not
test our second hypothesis here.
Table IX. 2SLS for put volume, bid-ask spreads, and the equity lending fee
Table IX reports the estimated results for the 2SLS regression used to alleviate concern that
the equity lending fee, put volume, and put bid-ask spreads are simultaneously determined.
Ln(P/S) is the natural logarithm of the daily put to stock trading volume ratio. The put bid-ask
spread is the highest closing bid less the lowest closing ask divided by the midpoint. Lending
fee is defined as the difference between the risk-free rate and the rebate rate, expressed as a
percentage. Dummy is a dummy variable that indicates whether the option strike price is no
greater than the stock price. Moneyness describes how much a put option is in or out of the
money. Time to maturity is the number of days to the put option’s expiration date. Stock vol-
ume is the daily stock trading volume. Ln(Size) is the natural logarithm of firm size at the end of

the last calendar month. B/M ratio is the book-to-market ratio at the end of the last calendar
volatility is calculated using the daily return in the previous month. Historical return skewness
is the skewness of daily stock returns in the previous month. Lendable share ratio is the fraction
of the value of lendable shares divided by the market capitalization. Institutional holding ratio is
defined as institutional holdings divided by the total number of shares outstanding at the last
quarter end. VIX is the daily VIX index value. S&P 500 index return is the daily return of the S&P
500 index. Stock return is the daily stock return. t-Statistics are calculated by using the Huber–
White heteroskedasticity-adjusted standard errors. ***, **, and * indicate that the estimated co-
efficient is significant at the 1%, 5%, and 10% level, respectively.
Ln(P/S) Put bid-ask spread Lending fee
Intercept 17.892*** 0.146*** 21.940***

(176.23) (113.17) (97.54)
Fitted lending fee 0.029*** 0.001***
(7.47) (16.76)
Fitted Ln(P/S) 0.004*** 0.226***
(13.71) (24.37)
Fitted put bid-ask spread 92.103*** 29.292***
(213.88) (28.38)
Dummy * moneyness 0.400***
(47.95)
(Dummy * moneyness)2 3.995***
(12.55)
(1–Dummy) * moneyness 0.527***
(39.50)
[(1–Dummy) * moneyness]2 0.730***
(7.06)
1/(time to maturity) 0.717***
(30.96)
S&P 500 index return 1.834***
(9.17)
Stock return 2.330***
(23.09)
Stock volume 0.000***
(3.86)
Institutional holding ratio 0.378***
(10.17)
(continued)
Table IX. Continued

Ln(P/S) Put bid-ask spread Lending fee
Lendable share ratio 13.593***

(155.39)
Ln(Size) 0.347*** 0.006*** 0.665***
(90.22) (139.98) (113.02)
B/M ratio 0.181*** 0.001*** 0.542***
(35.08) (16.93) (90.85)
Stock bid-ask spread 0.727*** 0.009*** 0.610***
(56.36) (85.55) (35.41)

Last month stock return 0.409*** 0.009*** 0.127***
(18.97) (46.09) (4.74)
Stock return volatility 6.906*** 0.085*** 5.135***
(34.31) (31.26) (20.27)
Historical return skewness 0.034*** 0.001*** 0.019***
(9.55) (24.96) (4.34)
VIX 2.190*** 0.021*** 0.886***
(65.17) (71.93) (19.47)
N 863,286
We then perform the following regressions, using P/(P þ C) as the dependent variable:
P=ðP þ C Þi;t ¼ b0 þ b1 Lending feei;t þ b2 Market returnt þ b3 Stockreti;t þ b4 Stockvoli;t

(16)
P=ðP þ C Þi;t ¼ b0 þ b1 Lending feei;t þ b2 Lending feei;t Bannedi;t þ b3 Bannedi;t
þb12 Skewnessi;m1 þ b13 IORi;q1 þ b14 VIXt
(17)
In the third column of Table X, we show that firms facing higher short-sale costs gener-
ally have significantly more put options than call options traded (t-statistic ¼ 3.87). This re-
sult supports the overall substitutability between the equity lending market and the put
options market. For Equation (17), the value of ðb1 þ b2 Þ is negative (0.368–
2.716 ¼ 2.348 with a p-value of the F-test < 0.000). For banned stocks in the banned
period, the last column shows that a higher equity lending fee is accompanied by a signifi-
cantly lower trading volume of put options relative to call options, which demonstrates the
complementarity between the two financial markets when only options market makers are
allowed to short.
Table X. Short-sale costs and put-call ratio
This table displays the pooled OLS regression results with the ratio of P/(PþC) as the dependent
variable. The ratio P/(PþC) is the ratio of daily aggregated put volume to the total volume of op-
tions traded, expressed as a percentage. Lending fee is defined as the difference between the
risk-free rate and the rebate rate, expressed as a percentage. Banned dummy is a dummy vari-
able indicating banned stocks in the banned period. Stock volume is the daily stock trading vol-
ume. Ln(Size) is the natural logarithm of firm size at the end of the last calendar month. B/M
ratio is the book-to-market ratio at the end of the last calendar year. Stock bid-ask spread is
defined as the closing ask less the closing bid divided by the midpoint. Last month stock return
is the cumulative stock return over the last month. Stock return volatility is calculated using the

daily return in the previous month. Historical return skewness is the skewness of daily stock re-
turns in the previous month. Institutional holding ratio is defined as institutional holdings div-
ided by the total number of shares outstanding at the last quarter end. VIX is the daily VIX
index value. S&P 500 index return is the daily return of the S&P 500 index. Stock return is the
daily stock return. Industry FE and year FE refer to controls for Fama–French twelve industry
fixed effects and year fixed effects, respectively. Estimated standard errors are double clustered
by firm and calendar year. ***, **, and * indicate that the estimated coefficient is significant at
the 1%, 5%, and 10% level, respectively.
Dependent variable: Ratio of P/(PþC)
Intercept 35.800*** 2.756 35.772*** 2.849

(13.92) (0.20) (14.03) (0.21)
Lending fee 0.213** 0.366*** 0.216** 0.368***
(2.52) (3.87) (2.51) (3.87)
(12.93) (20.64)
Banned dummy 21.310*** 3.359***
(8.43) (4.21)
S&P500 return 26.175*** 26.033***
(2.98) (3.02)
Stock return 85.885*** 85.938***
(9.51) (9.55)
Stock volume 0.018 0.018
(1.03) (1.03)
Ln(Size) 0.848* 0.844
(1.65) (1.64)
B/M ratio 2.985** 2.993**
(2.25) (2.25)
Stock bid-ask spread 0.959* 0.909
(1.67) (1.52)
Last month return 13.787*** 13.788***
(3.70) (3.69)
Stock return volatility 10.690 10.151
(0.78) (0.73)
Historical return skewness 0.299** 0.301**
(2.16) (2.16)
Institutional holding ratio 7.836*** 7.838***
(3.43) (3.43)
VIX 22.499*** 22.504***
(3.37) (3.37)
(continued)
Table X. Continued
Dependent variable: Ratio of P/(PþC)
Industry FE No Yes No Yes

Year FE No Yes No Yes
p-value of F-test for b1 þ b2 ¼ 0 N/A N/A <0.000 <0.000
N 285,784 248,911 285,784 248,911
Adj-R2 (%) 0.04 6.73 0.09 6.74

5.5 Sub-Sample Analysis of Banned Stocks During Short-Sale Ban
As a final robustness check, we re-test the second hypothesis, using only observations of
banned stocks during the Short-Sale Ban period. This procedure is intended to relax the as-
sumption that the relationships between our variables of interest and firm- and market-level
control variables are the same during the Global Financial Crises as during non-crisis
periods.
Following Grundy, Lim, and Verwijmeren (2012) and Johnson and So (2012), we apply
the same set of data filters applied in our main tests to alleviate the influence of illiquid op-
tions and exclude possible recording errors. As seen in Tables IV and V, we obtain similar
results (non-tabulated). Overall, our findings indicate that higher equity lending fees dis-
courage options market makers from writing puts because of more expensive hedging costs,
which is consistent with our hypothesis.
6. Conclusion
We integrate the two channels of interaction identified in the literature between equity
short selling and put options trading. First, short-sale costs can influence put options trad-
ing activity because higher short-sale costs may drive investors with negative private infor-
mation or a long position to hedge from the equity lending market to the put options
market. As a result, put options bid-ask spreads and trading volume may increase with
short-sale costs. Second, higher short-sale costs also raise the hedging costs of market mak-
ers in issuing put options, which will, ceteris paribus, reduce the put options trading volume
and increase put options bid-ask spreads because of the inward-shift of the put option
supply.
We find that, in general, the put options bid-ask spread and put options trading volume
both increase with the equity lending fee, which indicates that the outward shift of the de-
mand curve dominates the inward shift of the supply curve in the options market. This find-
ing is consistent with the notion that the two markets are substitutes for one another for
informed traders. However, when only put options market makers are allowed to short
banned stocks during the 2008 Short-Sale Ban period, the put options trading volume de-
creases with the equity lending fee. These results confirm that the “complementarity” be-
tween options trading and short selling comes from the supply-side channel in the options
market.
In addition, we find that lending fees are positively associated with the implied volatility
of put options, deviations from put-call parity, and the pattern of the implied volatility
smirk. Moreover, these effects are stronger for banned stocks during the 2008 Short-Sale
Ban. Together, these results suggest that the prices of put options and the price efficiency of
puts are related to short-sale costs. Our findings are also robust to the use of a 2SLS model
in the estimation, a specification that alleviates the concern that the results are driven by
the simultaneous determination of the put options trading volume and put options bid-ask
spreads. In addition, the results remain qualitatively similar when we use the ratio P/(P þ C)
to capture the put options trading volume.
In sum, our article adds to the literature on the interaction between short selling and put
options trading by disentangling the speculative demand of short sellers from the hedging
demand of options market makers in the equity lending market. By separating two types of
demand in the short-selling market, we provide a comprehensive analysis of the relationship

between the two markets.
Appendix A
Table AI. Effects of increases in short-sale costs and enforcement of the 2008 Short-Sale Ban
Table AI presents our empirical design. The lending fee is defined as the difference between
the risk-free rate and the rebate rate. Banned Dummy is a dummy variable indicating banned
stocks during the banned period. The put volume is measured by the natural logarithm of the
daily aggregated trading volume of put options scaled by the stock trading volume. The put
bid-ask spread is the highest closing bid less the lowest closing ask, divided by the midpoint.
The put implied volatility is used as a proxy for the price of a put option. IV Spread is a measure
of the deviation from put-call parity and is defined as the difference in the implied volatility
between matched pairs of calls and puts with the same strike prices and expiration dates. IV
Skew quantifies the implied volatility smirk, which is the difference between the implied volatil-
ity of the OTM put options and ATM call options that are written on the same underlying stock.
P/(P þ C) is the ratio of daily aggregated put volume to the total volume of options traded.
Panel A: Influences on options market makers and investors
Lending market Put options demand and supply

curves
Lending fee Reflects the speculative costs of short sellers A high lending fee causes the demand
and hedging costs of put options market curve to shift outward and the
makers. supply curve to shift inward in the
put options market.
Banned dummy * Only reflects the hedging costs of options A high lending fee only causes the
lending fee market makers, as other traders are not put option’s supply curve to shift
allowed to short. inward, as other traders are not
allowed to short.
Panel B: Expected correlations between proxies of put options trading activities and equity lending fees
P
Put volume Put bid-ask Put price IV IV ðPþCÞ
(LnðP=SÞ) spread (implied spread skew
volatility)
Lending fee ? þ þ þ ?
Banned dummy * lending fee þ þ þ
Appendix B: The 2SLS Regression Models

B.1 Simultaneous Determination of the Put Option Volume
and Bid-Ask Spreads
We perform the 2SLS regressions in the following form:
• Hypothesis 1:
LnðPj;i;t =Si;t Þ ¼ b0 þ b1 Putbaspj;i;t þ b2 Lending feei;t þ b3 Market returnt

þ b4 Stockreti;t þ b5 LnðSizeÞi;m1 þ b6 B=Mi;y1 þ b7 Stockbaspi;t

þ b12 VIXt þ ej;i;t :
(B.1)
Putbaspj;i;t ¼ b0 þ b1 LnðPj;i;t =Si;t Þ þ b2 Lending feei;t þ b3 Dj;i;t Moneynessj;i;t
þ b4 ½Dj;i;t Moneynessj;i;t 2 þ b5 ð1 Dj;i;t Þ Moneynessj;i;t
þ b6 ½ð1 Dj;i;t Þ Moneynessj;i;t 2 þ b7 ðMaturityj;i;t Þ1 þ b8 Stockvoli;t

þ b13 Volatilityi;m1 þ b14 Skewnessi;m1 þ b15 IORi;q1 þ b16 VIXt þ ej;i;t :
(B.2)
• Hypothesis 2:
LnðPj;i;t =Si;t Þ ¼ b0 þ b1 Putbaspj;i;t þ b2 Lending feei;t þ b3 Lending feei;t Bannedi;t

þ b4 Bannedi;t þ b5 Market returnt þ b6 Stockreti;t þ b7 LnðSizeÞi;m1
þ b12 Skewnessi;m1 þ b13 IORi;q1 þ b14 VIXt þ ej;i;t :
(B.3)
Putbaspj;i;t ¼ b0 þ b1 LnðPj;i;t =Si;t Þ þ b2 Lending feei;t þ b3 Lending feei;t Bannedi;t
þ b4 Bannedi;t þ b5 Dj;i;t Moneynessj;i;t þ b6 ½Dj;i;t Moneynessj;i;t 2

þ b13 Stockbaspi;t þ b14 Lagreturni;m1 þ b15 Volatilityi;m1 þ b16 Skewnessi;m1
þ b17 IORi;q1 þ b18 VIXt þ ej;i;t :
(B.4)
The S&P 500 Index return and the daily stock return are utilized as the
instrumental variables for the P/S ratio. Based on the results of the main hypothesis test-
ing, these two variables are significantly correlated with the P/S ratio and are not signifi-
cantly correlated with the put options bid-ask spread. The contract-level characteristics
and the daily stock volume are used as instrumental variables for the put options bid-ask
spread.
B.2 Simultaneous Determination of Put Volume, Bid-Ask Spreads,

and Lending Fees
To alleviate the concern that the equity lending fee and put options trading measures could
be simultaneously determined, we conduct the following the 2SLS regressions:
LnðPj;i;t =Si;t Þ ¼ b0 þ b1 Putbaspj;i;t þ b2 Lending feei;t þ b3 Market returnt þ b4 Stockreti;t

þ b9 Volatilityi;m1 þ b10 Skewnessi;m1 þ b11 VIXt þ ej;i;t
(B.5)

Putbaspj;i;t ¼ b0 þ b1 LnðPj;i;t =Si;t Þ þ b2 Lending feei;t þ b3 Dj;i;t Moneynessj;i;t
þ b4 ½Dj;i;t Moneynessj;i;t 2 þ b5 ð1 Dj;i;t Þ Moneynessj;i;t
þ b6 ½ð1 Dj;i;t Þ Moneynessj;i;t 2 þ b7 ðMaturityj;i;t Þ1 þ b8 Stockvoli;t

þ b13 Volatilityi;m1 þ b14 Skewnessi;m1 þ b15 VIXt þ ej;i;t :
(B.6)
Lending feei;t ¼ b0 þ b1 LnðPj;i;t =Si;t Þ þ b2 Putbaspj;i;t þ b3 Lendablei;t þ b4 IORi;q1

þ b9 Volatilityi;m1 þ b10 Skewnessi;m1 þ b11 VIXt þ ej;i;t
(B.7)
The lendable share ratio and the institutional ownership ratio are used as instrumental
variables for the equity lending fee. Both variables are proxies for the equity lending supply
and have been shown in previous studies to be significantly correlated with the equity lend-
ing fee (e.g., D’Avolio, 2002; Prado, Saffi, and Sturgess, 2014). Following Saffi and
Sigurdsson (2011), the lendable share ratio is defined as the value of lendable shares scaled
by market capitalization. The institutional ownership ratio is calculated as the fraction of
the number of shares held by institutional investors to total shares outstanding.
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Review of Finance Advance Access published October 14, 2015

Review of Finance, 2015, 1–33

How Do Short-Sale Costs Affect Put

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JEL classification: G11, G12, G14

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2.2 Short Selling As a Hedging Instrument for Put Options Market

3. Data and Descriptive Statistics

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4. How Do Equity Lending Fees Affect Put Options Trading?

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Year Firm 25% Median 75% Mean Std

Panel A: Equity lending fee (%)

LnðP=SÞi;t ¼ b0 þ b1 Lending feei;t þ b2 LnðSizeÞi;m1 þ b3 B=Mi;y1 þ b4 Stockbaspi;t

Putbaspj;i;t ¼ b0 þ b1 Lending feei;t þ b2 Dj;i;t Moneynessj;i;t þ b3 ½Dj;i;t Moneynessj;i;t 2

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þ b6 ðMaturityj;i;t Þ1 þ b7 Stockvoli;t þ b8 LnðSizeÞi;m1 þ b9 B=Mi;y1

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4.2 Disentangling the Speculative Demand from Hedging Demand in

4 See SEC Emergency Order (34-58592).

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Dependent variable: Ln(put volume/stock volume)

Intercept 6.086*** 6.086*** 12.778*** 12.521***

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Dependent variable: Put bid-ask spread

Intercept 2.869*** 3.111*** 19.166*** 22.623*** 22.615***

Table III. Continued

Institutional 0.860* 1.312*** 1.313***

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LnðP=SÞi;t ¼ b0 þ b1 Lending feei;t þ b2 Lending feei;t Bannedi;t

Putbaspj;i;t ¼ b0 þ b1 Lending feei;t þ b2 Lending feei;t Bannedi;t

þ b3 Bannedi;t þ b4 Dj;i;t Moneynessj;i;t þ b5 ½Dj;i;t Moneynessj;i;t 2

þ b6 ð1 Dj;i;t Þ Moneynessj;i;t þ b7 ½ð1 Dj;i;t Þ Moneynessj;i;t 2

þ b8 ðMaturityj;i;t Þ1 þ b9 Stockvoli;t þ b10 LnðSizeÞi;m1 þ b11 B=Mi;y1 (6)

þ b12 Stockbaspi;t þ b13 Lagreturni;m1 þ b14 Volatilityi;m1

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Dependent variable: Ln(put volume/stock volume)

Intercept 6.086*** 6.086*** 12.781*** 12.520***

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Dependent variable: Put bid-ask spread

Intercept 2.862*** 3.104*** 19.400*** 22.763*** 22.759***

Historical return skewness 0.066 0.012 0.012

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5. Additional Tests and Robustness Checks

5.1 Short-Sale Costs and Put Options Implied Volatility

IVolj;i;t ¼ b0 þ b1 Lending feei;t þ b2 Dj;i;t Moneynessj;i;t þ b3 ½Dj;i;t Moneynessj;i;t 2

þ b4 ð1 Dj;i;t Þ Moneynessj;i;t þ b5 ½ð1 Dj;i;t Þ Moneynessj;i;t 2

þ b6 ðMaturityj;i;t Þ1 þ b7 Stockvoli;t þ b8 LnðSizeÞi;m1 þ b9 B=Mi;y1

IVolj;i;t ¼ b0 þ b1 Lending feei;t þ b2 Lending feei;t Bannedi;t þ b3 Bannedi;t

Moneynessj;i;t þ b7 ½ð1 Dj;i;t Þ Moneynessj;i;t 2 þ b8 ðMaturityj;i;t Þ1

þ b13 Lagreturni;m1 þ b14 Volatilityi;m1 þ b15 Skewnessi;m1 þ b16 IORi;q1

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5.2.a Put-call parity deviation

Table VI. Short-sale costs and put options implied volatility

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Dependent variable: Put options implied volatility

Intercept 41.908*** 138.114*** 41.874*** 138.197***

Table VI. Continued

Intercept 6.086* 6.086* 12.778* 12.521*

Intercept 2.869* 3.111* 19.166* 22.623* 22.615***

Institutional 0.860* 1.312* 1.313*

Intercept 6.086* 6.086* 12.781* 12.520*

Intercept 2.862* 3.104* 19.400* 22.763* 22.759***

Intercept 41.908* 138.114* 41.874* 138.197*

Intercept 20.180* 19.232* 20.510* 18.957*

Intercept 17.892* 0.146* 21.940***

Intercept 35.800* 2.756 35.772* 2.849