Determinants and Effects of Option Listings: Evidence from ADRs

In this paper, we test the assertion that options act as a substitute for short sales by allowing investors an alternative way to act on bearish sentiment. An empirical test of this assertion requires a researcher to observe both types of firm - those that weren’t short sale constrained, as well as those that were. We examine the ability of options to alleviate the short sales constraint directly - in an environment where the constraint is likely to differ across firms in a systematic fashion, namely the market for American Depository Receipts (ADRs). We examine 190 option introductions on ADRs over the period of 1982 to 2006. The question of how ADRs are chosen for options listing, and whether those criteria differ from those found using purely domestic options is addressed using logistic regressions. We use the event study methods of Brown and Warner (1985) to examine the price effect of the listing. We use OLS regression to identify determinants of the cumulative abnormal return upon option listing. Independent variables are those indicated by existing literature that examines option listing on domestic securities. In an environment where the effective short sale constraint varies across firms, we find support for the contention that U.S. option listings reduce the effect of the short sales constraint, providing relief for investors who have negative sentiment about the stock and are subject to a short sale constraint. However, it does not appear that option listing entities seek out companies for which short sale constraints are stronger. Our hypotheses are similar to those of Mayhew and Mihov (2004) and Danielson and Sorescu (2001), but we assert that the ADR market is a more robust environment in which to test the hypotheses. This is due to the potentially large variation in the effective short sale constraints that results from the differences in their underlying home market legal and regulatory environments. In addition to relative short interest and the change in relative short interest, this environment allows us to use indicator variables to directly test the ability of options to substitute for short sales.