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Overcoming Arbitrage Limits: Option Trading and Momentum Returns

Published online by Cambridge University Press:  05 October 2023

Abhay Abhyankar ,
Ilias Filippou Open the ORCID record for Ilias Filippou [Opens in a new window]  and
Pedro A. Garcia-Ares
Abhay Abhyankar
Affiliation:
MOVE [email protected]
Ilias Filippou*
Affiliation:
Washington University in St. Louis Olin School of Business
Pedro A. Garcia-Ares
Affiliation:
Instituto Tecnológico Autónomo de México (ITAM) Department of Finance [email protected]
*
[email protected] (corresponding author)
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Abstract

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

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

Footnotes

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

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