The Effect of Option Listings: Evidence from American Depository Receipts
by
Spencer A. Case*
Hankamer School of Business
Baylor University
Janet D. Payne
McCoy College of Business
Texas State University
Abstract
This paper investigates the effect of option listings on underlying securities using the market for
ADRs. Unlike the U.S. domestic equities, the short sale constraint differs widely for ADRs due
to country specific legal restrictions on short selling and options availability. Our results show
that U.S. options exchanges have no preference for listing ADRs that are subject to higher short
sale constraints. We find no decrease in volatility or increase in short interest with option listing.
The abnormal return upon option introduction is less negative when the ADR is less short sale
constrained, consistent with option listings mitigating short sales constraints.
JEL Classification: G12, G14, G18
Keywords: options, ADRs, short sale constraint
* Please address correspondence to Spencer Case (Spencer_Case@Baylor.edu), Hankamer School of Business,
Baylor University, Waco, TX 76798. Ph:254-710-4145; Fax:254-710-1092.
The Effect of Option Listings: Evidence from American Depository Receipts
1. Introduction
Danielson and Sorescu (2001) extend the theoretical model of Miller (1977) and Jarrow
(1980) to examine the effect of removing the short sale constraint on prices of underlying
securities. They conclude that removal of that constraint will result in predictable decreases in
underlying security prices. They test their hypothesis in what they describe as a laboratory
setting, where option introductions represent a reduction in short sale constraints. They find a
puzzling result - prior to 1981, stock price reactions are positive, though after 1981, stock price
reactions are negative. Since the legal and regulatory environment which causes the short sale
constraint is virtually the same across all domestic firms, there is no clear control group for
which options are introduced but where there is a substantially lower or nonexistent short sale
constraint. In an ideal setting, a researcher would want to observe firms that had options
introduced but weren’t short sales constrained, as well as firms that have options introduced that
do have binding short sales constraints. A more robust test would take place in an environment
where short sale constraints have identifiable cross-sectional variation. We examine the price
effect of option introductions in an environment where the short sale constraint is likely to differ
across firms, namely the market for American Depository Receipts (ADRs). Because we have
cross-sectional variation in the sample (firms that have high levels versus firms that have
relatively low levels of short sale constraint due to differences in the home market legal
environment), we can examine the effect of introducing options on lesser constrained firms
versus more constrained firms. These lesser constrained firms in essence act as the control group
that would otherwise be absent or problematic to identify in a single country setting. We find
1
that, if neither put options are available for trading nor short sales are allowed in the home
country, the ADR is no more likely to have an option introduced in the U.S. The (negative, on
average) abnormal return associated with option introduction is positively associated with put
option availability and unrelated to the availability of short sales in the home country (the
country in which the underlying security originates).
American Depository Receipts are negotiable certificates traded on a U.S. exchange,
issued by a U.S. bank, representing a specified number of shares in a foreign stock. We examine
190 option introductions on ADRs over the period of 1982 to 2006. We first examine the choice
by the options exchanges to list options on ADRs, similar to the examination of options listings
on domestic firms as seen in Mayhew and Mihov (2004). Several authors including Trennepohl
and Dukes (1979), Conrad (1989), Bansal, Pruitt, and Wei (1989), Skinner (1989),and
Damodoran and Lim (1991) find that there is a decrease in the volatility of the underlying
security after the options are introduced, with Mayhew and Mihov (2004) and Bollen (1998)
being exceptions, they do not find a decrease in volatility. Likewise, we do not find this decrease
in volatility among optioned ADRs. Mayhew and Mihov (2004) find that trading volume,
volatility and market capitalization are determinants of option listing. We find that relative daily
volume during the period before the listing and market capitalization in the U.S., are the only
significant determinants of selection of ADRs for option listing. Volatility as measured by
standard deviation or beta does not appear to be a factor by which ADRs are selected for option
listing.
Like previous studies on domestic securities, which have excluded ADRs, we find that
the introduction of options on ADRs has a significant and negative influence on the price of the
underlying security. In contrast, the non-optioned ADR matches have a positive price reaction to
2
news of an option listed on their counterpart. When examining the optioned firms, the price
reaction is positively related to changes in relative short interest and the availability of puts in the
home country. The change in volume, positive price change and the standard deviation of
returns prior to the listing all have a negative influence on returns around the option listing date.
The price reaction is unrelated to previous capital-raising by the ADR firms in the U.S. market or
the legality of short sales in the home country. We find that when home country investors have a
fairly strict constraint of “short sale illegality,” the price response to option listing in the US
market is insignificant. However, if the home country for the ADR already has put options
available, the stock price response is far more positive than would otherwise be the case.
The remainder of this paper is organized as follows. Section 2 contains a concise review
of the prior literature as well as presenting our research hypotheses. Section 3 includes
institutional details that are relevant to this study. Section 4 provides a description of our sample
selection and empirical methods. Results are in Section 5, and Section 6 concludes.
2. Background and Hypotheses
Several previous studies have examined which stocks are chosen for options listing. In
one of the earliest studies of listing choice, Cowan, Carter, Dark and Singh, (1992) empirically
investigate the listing of firms on the NYSE. Among those firms that are eligible for NYSE
listing, they examine the determinants of those that are ultimately chosen to be listed by the
NYSE. However, as noted by Mayhew and Mihov (2004), the choice of option listing is
fundamentally different. Whereas firms apply to be listed on exchanges like the NYSE, the
choice of option listing is dependent upon the options exchange and not the firm. In fact, the
firm itself and or the government of the home country could protest in opposition to the listing of
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options, as was the case with many Japanese firms. Mayhew and Mihov (2004) investigate the
determinants of that selection for domestic firms. They use a control sample method and find
that stocks with high trading volume, volatility and market capitalization are more likely to have
options listed. They also find that these relations have changed somewhat over time, with a shift
from volume toward volatility after institutional changes in 1980.
Early studies, beginning with Branch and Finnery (1981) and corroborated by Skinner
(1989) , DeTemple and Jorian (1990) and Conrad (1989), find that the introduction of options
was associated with a positive excess returns for option introductions in the U.S. In later work
Sorescu (2000) finds that there was a dramatic change in the price effect of option introductions
on the underlying security. In the time period before 1980, price changes were positive, and
after 1980 they became negative. Major regulatory changes in 1980-1981 as well as the
introduction of index options in 1982 were cited as potential reasons for the shift. Danielsen and
Sorescu (2001) include relative short interest to provide additional evidence related to the
possibility that the decreases in price were due to diminishing short sale constraints. Asquith
and Meulbroek (1995) outline several of these short sales constraints. First, because the
proceeds of the short sale are held in the brokerage account with no interest earned, there is an
indirect transaction cost to the short sale. The investor must be very bearish on the stock to
entice him to enter this position. Until more recently, SEC rule 10a-1 required that short sales
not be executed at a price below the preceding transaction price. In addition, the short seller
must find a willing lender for the shares. Finally, the lack of ability to find shares for repurchase
(a short squeeze) can be very costly for the investor.
In addition to facts about stock price changes upon option listing, it has been previously
shown by several authors that stock return variances decrease significantly following the listing
4
of options on the underlying security. The earliest evidence of this decline was provided by
Trennepohl & Dukes (1979), Conrad (1989), Bansal, Pruitt, and Wei (1989) and Skinner (1989),
all of whom find significant declines in volatility ranging from less than 1% to more than 6%.
More recent evidence by Damadoran and Lim (1991) finds a drop in volatility of approximately
20%. In more recent studies this decrease in volatility is drawn into question. St. Pierre (1998)
uses an EGARCH model and finds that the conditional volatility of security returns is unaffected
by option introduction. Bollen (1998), who uses a control sample matched on industry, does not
find a significant decrease in volatility after option listing. Mayhew and Mihov (2004) compare
optioned firms to a pooled sample of all non-optioned firms that were eligible to be optioned and
do not find a change in volatility after option listing. The use of differing control sample
methods might partially explain the differing results from past studies. According theoretical
work by Cao (1999), the volatility effect of option listing has the potential to spill over to other
stocks, particularly when there is a high correlation with the optioned stock. Thus, non-optioned
stocks in the control sample could be affected by the option listings.
The general relation of the pricing of an ADR with the equivalent shares in the home
country has been the subject of much interest. Rosenthal (1983) shows that abnormal profits
could not be earned on ADRs from any price dependence. Likewise, Kato , Linn and Schallheim
(1991) and Wahab and Khandwala (1992) find that after accounting for transaction costs, there
were few profitable opportunities to arbitrage the ADRs between the U.S. and the home market
for the underlying security. Still other authors, such as Mathur, Gleason and Singh (1998), Kim,
Szakmary and Mathur (2000) and Kim, Chen and Chou (2002), investigate the dynamic linkages
of price movements between the home country and the U.S. Generally, the findings are that the
linkage is strong, and that most price shocks are corrected quickly in each country.
5
Legal environments and investment barriers vary by country and those variations are
often important determinates of market efficiency or firm level market performance. Foerster
and Karolyi (2000) investigate the long run performance for capital raising depository receipts.
They find that differences in long-term performance after raising capital are related to the scope
and magnitude of investment barriers in the home country. Bris, Goetzmann, and Zhu (2004)
analyze forty-six equity markets around the world. They find that prices incorporate information
faster in countries where short sales are allowed and practiced. Daouk and Charoenrook (2005)
study short sale and put option trading regulations and practices from 111 countries. They find
that when short-selling is legally permissible, liquidity is higher. They also find a stock price
increase associated with countries relaxing their short sale constraints. ADRs are different than
domestic securities, in that important firm level characteristics can vary widely due to differing
legal environments, investment barriers and other factors specific to the home country of each
firm.
Our hypotheses are similar to those of Danielson and Sorescu (2001) and Mayhew and
Mihov (2004), but our conjecture is that the ADR market is a superior environment in which to
test the hypotheses. This is due to the potentially large variation in short sale constraints that
results from the differences in their underlying home market legal and regulatory environments.
Specifically, we test:
i) Options on ADRs are chosen for listing based on criteria similar to that found by
Mayhew and Mihov (2004) i.e. size, volume, and volatility being significant
determinates.
ii) Options exchanges are more likely to introduce options on ADRs from countries that
are more short sale constrained; where the more constrained ADR’s home country does
6
not allow short selling or there are not puts available for trading.
Similar to Danielson and Sorescu (2001), we hypothesize that, upon option introduction:
iii) Stock price reaction will be negative.
iv) Short interest will increase.
v) Stock price reaction will be negatively related to beta.
vi) Stock price reaction will be negatively related to changes in short interest.
Given our unique ADR sample and experimental design, we also test:
vii) The lack of short sales or put options in the underlying ADR’s home market will
result in a more negative stock price reaction to the option introduction. i.e. ADRs with
stronger short sales constraints will have a more negative stock price reaction when
options are introduced in the U.S..
3. Institutional Details
As described in Mayhew and Mihov (2004), option exchanges are member-owned selfregulating organizations, and are subject to federal securities laws and oversight by the Securities
and Exchange Commission. The SEC has played a large role in selection of stocks for option
listing, particularly in the beginning of the options market, in 1973. In July of 1977, the SEC
announced plans for an extensive review of options trading, and asked for a voluntary
moratorium on expansion.1 That review, released in February of 1979, resulted in rules changes
by the exchanges. At that time, the SEC lifted the moratorium on expansion and option trading
was considered a permanent institution.2
1
Securities and Exchange Commission, Securities Exchange Act of 1934, Release No. 13760, 1977.
2
Securities and Exchange Commission, Securities Exchange Act of 1934, Release No. 16701, 1980.
7
Over time, there have been changes in eligibility requirements for domestic stocks, as
outlined in Table I of Mayhew and Mihov (2004). Those different eligibility regimes were used
as delineating factors in their study. In a study of option listings on ADRs, however, those
regimes are less relevant because ADRs and other foreign securities are often treated differently
than domestic securities. According to the SEC, American Depository Receipts are exempt from
many rules relating to options listing on domestic securities, except for the requirement that they
be listed on a national exchange.3 The same is true of short sale constraints. For example, the
uptick rule, largely in place for domestic securities during our sample period, was not a
requirement of a short sale on an ADR, under the “International Arbitrage Exemption.”4 ADR
specific criteria for listing include: the existence of a monitoring agreement between the U.S.
stock exchange and the home market stock exchange, a majority of the trading volume taking
place on the U.S. exchange and a minimum track record for trading in the U.S. Despite the
actual guidelines provided by the SEC, approval for individual ADRs has largely been done on
an ad hoc basis.
4. Sample Selection and Empirical Methods
We used the Center for Research in Security Prices (CRSP) to identify American
Depository Receipts. Our sample included ADRs traded from 1982 to 2006. There were 828
unique ADRs trading at various points in time on the CRSP database, 799 of those from
countries classified by Daouk and Charoenrook (2005). The individual option listing dates were
3
4
Securities and Exchange Commission, Securities Exchange Act of 1934, Release No. 31531, 1992.
Securities and Exchange Commission, Securities Exchange Act of 1934, Release No. 2039, 1939. The rule was
updated and extended to NASDAQ in Release No. 34-37492, 1996.
8
provided by the Chicago Board Options Exchange (CBOE). Of the securities in our sample, we
identified 190 that had listed options on any of the option exchanges tracked by the CBOE. The
country of origin for each ADR was identified using Standard and Poor’s Research Insight. We
used Standard and Poor’s Daily Stock Reports to obtain short interest data and used CRSP for
the returns, prices and volume data.
Our empirical methods follow previous authors in the area of domestic options listing.
To test differences in volatility, volume and short interest, we use the firm’s beta, standard
deviations of returns before and after the option listing, volume before and after the option listing
and relative short interest before and after the option listing. We use t-tests to calculate the
statistical significance of any differences.
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
with the dependent variable being a dummy variable equaling 1 if the security had an option
listed, and 0 if it did not.
(1)
We use two variables to describe volatility in the underlying ADR. The first is the beta
calculated in the market model regression used to calculate abnormal returns, as defined in
equation (2) below. The second is the standard deviation of daily returns from 90 days prior to
30 days prior to the listing. The next three variables measure short interest in the period prior to
the option listing. Relative short interest is short interest/shares outstanding measured both one
9
month and three months before the listing. The change in short interest is the percent change in
short interest from one month prior to the month the option was introduced. We measure size
using log of market capitalization in the U.S, 90 days months prior to the option listing. Change
in price from nine months prior to three months prior to option listing measures return prior to
the ADR being selected for option listing. Relative daily volume, average daily volume and
change in volume are used to measure liquidity over the period before the option listing.
Average daily volume and relative daily volume are both measured from 90 days prior to 30 days
prior to the option listing, with relative daily volume calculated as average daily volume per
1000 ADR shares in the U.S. market. Change in volume is the percentage change over a six
month period ending three months prior to the option listing. “Put” is an indicator variable equal
to 1 if put options are legal in the home market at the time the option is listed in the U.S.,
otherwise 0. “Short” is in indicator variable equaling 1 if short sales are legal in the home
market at the time the option is listed in the U.S., otherwise 0. “Neither put nor short” is an
indicator variable equaling 1 if neither put options nor short sales are legal in the home country,
otherwise 0.
In constructing the sample, we use a matched sample technique conceptually similar to
Mayhew and Mihov (2004) and Bollen (1998). We found individual matches for each ADR first
by selecting from ADRs from the same country, then by the closest in size (measured by market
capitalization in the U.S.) 90 days prior to option listing. We were able to successfully find 177
matches for our optioned ADRs, 13 had no viable match due to there being no other nonoptioned same country ADRs on CRSP at the time the option was listed. Of those, 157 had full
data available for both the optioned ADR and its matched firm for the calculation of CAR
described below.
10
We use the standard event study methods of Brown and Warner (1985) to examine the
price effect of the listing, as done in Sorescu (2000) and others. Abnormal return is defined for
each of the seven days starting five trading days prior to the event and ending one trading day
after the event as:
AR ADR  R ADR     * R Index,
(2)
where α and β are estimated during the period from 120 to 20 days prior to the option listing
using a market model with the CRSP equally weighted market index. The market and ADR
returns are the actual returns during the seven day event window from 5 days prior to one day
after the option listing. The cumulative abnormal return (CAR) is the sum of the seven days’
abnormal returns. Significance of the CAR is tested using a Z-statistic as follows:
Z
 CAR
N
1
N
i 1
ADR
Var (CARADR )
1
2

(3)
We use OLS regression to identify determinants of the cumulative abnormal return.
Specifically, the full model we use is:
(4)
Independent variables are those indicated by existing literature that examines option listing on
domestic securities, as well as those discussed in the previous section. We use three alternative
measures for long-run return before the option listing. CRBO is an indicator variable equal to 1
if capital was raised via the ADR in the U.S. market sometime before the option was listed on
11
that ADR, otherwise it is equal to 0 (see Foerster and Karolyi (2000) for details pertaining to
capital raising ADRs). Price change is measured over a six month period ending three months
prior to the option listing. Positive price change is an indicator variable equaling 1 if that price
change was an increase, otherwise 0. Our next two variables measure short interest in the period
prior to the option listing. Relative short interest is short interest divided by shares outstanding
in the month prior to listing. Change in relative short interest is the percent change in short
interest from one month prior to the month of the option listing. We use two variables to
describe volatility in the underlying ADR. The first is the standard deviation of daily returns
from 90 days prior to 30 days prior to the listing. The second is the beta calculated in the market
model regression used to calculate abnormal returns, as defined in equation (2) above. Relative
daily volume and change in volume are used to measure liquidity over the period before the
option listing. We also use two indicator variables (Put and Short) to access whether an ADR is
likely to be short sales constrained. The standing proposition is that ADRs from countries with
available put options would effectively be less short constrained than a similar ADR from a
country without put options. Likewise, ADRs from countries that ban short sales are more
constrained than are ADRs from countries that allow short selling. As discussed below, we
develop a parsimonious model incorporating the most important proxies for each of the five
categories above. For robustness, we use White’s correction, along with three other adjustments
for heteroscedasticity suggested by Davidson and MacKinnon (2004). None of the tests for
heteroscedasticity proved to be statistically significant and none of the adjustments would
materially change our results. So then, all statistics reported in Table 5 reflect standard OLS.
5. Results
12
As shown in Panel A of Table 1, optioned firms tend to have larger U.S. market
capitalization, with higher relative trading volume and higher betas than their non-optioned
counterparts. Relative daily volume for the optioned ADRs is statistically higher than the nonoptioned matches, before, during, and after the option listing. There was not a statistically
significant change in relative daily volume from the period prior to the option listing to the
period after the option listing for either the optioned or non-optioned matches. When the change
in relative daily volume for the period prior and the period after the option listing is compared
for the optioned ADRs and non-optioned ADRs, the two groups were not significantly different.
For the standard deviation of returns and the relative short interest, there were no meaningful
differences between the optioned and matched ADRs. There was a slight increase in standard
deviation and relative short interest in the time period just around the options introduction for
both the optioned and matched ADRs. These increases didn’t rise to the point of statistical
significance for either the optioned or non-optioned ADRs.
Using the classifications presented in Daouk and Charoenrook (2005), we partition the
sample into groups where home country short sales were legal at the time the option was
introduced, versus those where short sales were not legal when the option was introduced. In
Panel B we show the 799 of the 828 ADRs in CRSP that have country codes corresponding to
the classifications presented by Daouk and Charoenrook (2005). 674 are from countries in
which short sales are legal, 159 of those ADRs (23.59%) are optioned. Of the 125 firms that
originate in countries where short sales are illegal, 31 (24.8%) of their ADRs are optioned in the
U.S. If options are intended by the exchanges as a lower cost substitute for the costly or
nonexistent ability to sell short, then a large proportion of ADRs chosen for option listing in the
U.S. would likely be based in countries where short sales are more constrained. This doesn’t
13
seem to be the case for our short selling indicator, according to a Chi-Squared test. There is no
significant different in the proportion of optioned ADRs that originate in countries where short
selling is legal vs. illegal. We then partition the sample into two groups where home country had
put options available for trading at the time the option was introduced, and those where traded
put options were not available when the option was introduced. Of the 629 ADRs for which put
options exist in the home country, 141 (22.42%) are optioned in the U.S. For the 170 ADRs
where tradable put options do not exist in the home country, 49 (28.8%) are optioned in the U.S.
A slightly higher percentage of ADRs are from countries without put options (p-value .0817)
than are from countries that already have tradable put options. Additional analysis will attempt
to ascertain whether or not that higher percentage is driven by option exchanges attempting to
complete markets where short selling is problematic or if other factors are driving the decision to
list options on these ADRs.
[INSERT TABLE 1 HERE]
We next use a logit analysis to identify factors driving the decision of option exchanges
to list options on ADRs. The findings in the logit analysis, presented in Table 2, concur in large
part with those of Mayhew and Mihov (2004), but with some important differences. As they
find, we also find that size (market capitalization in the U.S.) to be positive and significant
determinant of option listing. We also find that volume as measured by relative daily volume
and not simple volume is the relevant measure for ADRs in determining option listing. Unlike
their findings on domestic securities, we do not find the risk level to be a significant factor,
whether measured by standard deviation or by an alternative measure beta. After controlling for
14
other factors, the availability of short sales and put options in the home country does not appear
to influence U.S. options exchanges when choosing ADRs for option listing. When included
independently of the short and put dummy variables, the dummy for neither put nor short is still
not statistically significant. We believe that model 4 is better specified by the inclusion of only
the dummy for neither put nor short. This finding indicates that if investors can not act on their
negative beliefs, via either a short sale or a put option in the home country, then the option
exchanges in the U.S. market are not more likely to introduce an option to allow them to do so.
The option exchanges do not appear to be listing options on firms to alleviate the short sale
constraint for the most constrained ADRs.
[INSERT TABLE 2 HERE]
The remainder of our analysis examines the stock price reaction to option listing. Panel
A of Table 3 shows the CARs for all available optioned ADRs versus their non-optioned
matches. The CAR for the optioned ADRs is significantly negative, consistent with findings on
U.S. domestic equity markets during the same time period. The CAR for non-optioned matches
is significantly positive for the same time period. When matched one to one, where data are
available for both the optioned and matched ADRs, shown in Panel B, the CAR for this matched
sample is still positive but no longer statistically significant. In Panel C, we examine the
significance of ADRs home market characteristics on the announcement effect of option listing.
We find that ADRs whose home countries allow put options have a significantly negative stock
price reaction upon listing. Those with no put options have no significant stock price reaction.
This finding is somewhat counter-intuitive, given that ADRs with puts available in the home
15
country already have an avenue for investors to express their negative sentiment regarding a
security. The difference of means tests do not find a significant difference between the
announcement effect for firms from countries in which puts are not available and those in which
puts are available. These simple univariate tests, however, do not account for other factors
which can simultaneously influencing the market reaction to the option introduction; an analysis
is presented in table 5 to address this issue. We also separate the sample into ADRs from
countries in which short sales are allowed and those in which short sales are not allowed. We
find that neither group has a significant announcement effect, and that there was no significant
difference between the announcement effects of the two groups.
[INSERT TABLE 3 HERE]
In table 4, we report the cumulative abnormal returns for the option listed ADRs and their
matches on a country by country basis. The most prevalently optioned ADRs were from U.K.,
Mexico, France and Japan. We find that the differences are not statistically significant for the
optioned versus non-optioned firms for any single country. Various groupings, not shown in the
table, such as European Union, G8, East Asian, and Latin American countries likewise failed to
show a significant difference between the optioned ADRs and the non-optioned matches. Next,
we use OLS regression to examine the determinants of the abnormal return for optioned ADRs.
For the cross sectional regressions several model specifications are presented. Regression
analysis shows that the CAR is determined by many of the same factors already identified by
Danielson and Sorescu (2001).
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[INSERT TABLE 4 HERE]
As described in Section 4, we use three alternative measures for performance before the
option listing – percentage change in price before the listing, a dummy variable equaling 1 if that
change is positive, and CRBO an indicator variable equaling 1 if the ADR resulted in capital
raising by the firm prior to the option being listed. The percentage change in price is not a
significant determinant of announcement effect. The indicator variable for a positive price
change is almost universally negative and significant, indicating that positive price performance
before the option listing results in a larger decline in price upon the listing announcement.
Foerster and Karolyi (2000) find that capital raising issues for ADRs were significant events that
influenced long run returns for those firms. The CRBO variable proves to have an insignificant
influence on abnormal returns, after controlling for other explanatory factors. The first three
models include CRBO, while the last four do not. The elimination the CRBO variable from the
later models results in no significant loss in explanatory power for the overall model. When all
three variables are included in the model, only positive price change is significant. With the
elimination of both CRBO and change in price, positive price change remains negative and
significant. Thus we choose that variable to describe the ex ante performance for our
parsimonious specification in Model 7.
Danielson and Sorescu (2001) find changes in short interest which are consistent with the
mitigation of short sale constraints. We use two alternative measures of short interest in our
model – relative short interest one month prior to the option listing and change in relative short
interest. Our measure of change in short interest is consistently significant, with a strong
positive influence on the price response when options are introduced. Given the significance
17
levels, the final model contains only the change in relative short interest. The actual marginal
effect of a change in short interest is rather modest. Nonetheless, firms with increased short
interest prior to the option being listed are likely to have a higher abnormal return.
According to Danielson and Sorescu (2001), the price of high beta stocks will decline by
more than that of low beta stocks. For robustness we include two measures of risk – beta and
standard deviation. In our regressions, we do not find support for Danielson and Sorescu’s
(2001) hypothesis about beta as it pertains to the ADR market, but we do find that higher
standard deviation results in larger price declines. As can be seen from Table 1, the optioned
firms do have higher betas, but beta is an insignificant factor in the price change when the option
was listed. In all models in which beta is not included, standard deviation is an important
negative determinant of stock price reaction at option listing. Firms with higher dispersion
before options listing experience lower (more negative) abnormal returns relative to those with
lower dispersion. We also include two alternative measures of liquidity to explain the cross
sectional variation in the market’s response to the option listing: relative daily volume and
change in volume. Relative daily volume has no significant effect on stock price reaction to
option listing. However, ADRs with a higher change in volume prior to the option listing suffer
greater price declines upon option listing. The findings to this point suggest that when options
are introduced on ADRs that had a positive price change, high volatility and large change in
volume, there is a larger decline in value than if they had not experienced this stock price
increase, were not as volatile, and were not as frequently traded.
To take advantage of the cross sectional variation in the legal and regulatory
environments in which ADRs exist and thus the potential variation in short sale constraints, we
include two variables to describe the underlying market structure. The first is a dummy variable
18
that is equal to one if put option trading is possible in the home country, as indicated by Daouk
and Charoenrook (2005) and zero otherwise. We expect that coefficient to be positive, since the
introduction of options shouldn’t relieve the short sale constraint as much where puts are already
available in the home country. We find that coefficient to be significantly positive in all models.
The marginal effect of having puts available vs. not available in the home country is 3.39%.
This clearly shows that when ADRs are effectively less short sales constrained they do not suffer
as great a decline in price as the ADR that were more short sales constrained. The second
variable is equal to one if short sales are legal in the home country, as indicated by Daouk and
Charoenrook (2005), and zero otherwise. We also expect the coefficient on that variable to be
non-negative, since ADRs from countries where short selling is legal would likely be less short
sales constrained than ADRs from countries where short selling is illegal. We find that
coefficient to be insignificantly different from zero. Operating under the general assumption that
option introductions would tend to depress securities prices. This result, combined with our
other findings, indicates that the introduction of options on ADRs tends to relieve the short sale
constraint for ADRs based in countries where put options are unavailable. However, the
availability or unavailability of short sales in the home country has no effect on the stock price
reaction to option introductions on ADRs. One possible cause for this result is that even if short
sales are available in the ADRs’ home country, shorting stocks can still be quite costly and
impose a substantial constraint on par with that in the United States.
Our final regression represents a parsimonious model, using the most significant factors
from the previous analysis. As before, price increase before the option listing, increases in
volume and volatility negatively affect the stock price reaction, while change in relative short
interest and the availability of put options in the home country have positive stock price effects.
19
So in summary, we find at least some support for hypotheses i, iii, and vii. Options on ADRs are
listed for many of the same reasons as for domestic stocks, the primary factors being market
capitalization in the U.S. and relative daily volume. We find a decline in ADR prices upon
listing announcement. We also find that ADRs from countries in which put options are not
available experience larger price declines than those from countries where put options are
available. We do not find this difference for ADRs with respect to the legality of short sales in
the home country. We do not find direct support for hypothesis v, the cross-sectional regression
does not find beta to be a significant determinant of price reaction to option listing. However,
total risk as measured by standard deviation, rather than systematic risk, is a significant negative
factor. We find no support for hypothesis iv and vi. No significant decline in short interest is
observed from before the option listing to after the option listing. The cross sectional relation of
short interest to abnormal return is not negative, rather a positive relation exists for ADRs. Our
findings do not support hypotheses ii: rather than introducing options on firms from countries
with neither short sales nor put options available, it seems that option listing organizations have
no preference for those ADRs, even though those are the most short sale constrained.
[INSERT TABLE 5 HERE]
6. Conclusions
We examine the decision of the option exchanges in the U.S. to list options on ADRs
from 1982 to 2006. We find evidence that options on ADRs are not introduced by the options
exchanges as intentional substitutes for short sales or for lack of existing put options in the home
market. Most ADRs that have options introduced are based in countries where short sales are
20
legal and put options are already available for trading. The logit model results indicate that
ADRs whose home country has neither short sales nor put options are no more likely to be
chosen for option listing in the U.S than are other ADRs. The evidence regarding the option
listing on domestic securities (Mayhew and Mihov 2004) suggests that for more recent listings,
the most important factors in determining whether or not an option was listed are size, trading
volume and volatility. Our findings support that both volume (relative daily volume) and size
(market capitalization in the U.S.) are determinants in the decision to list by the exchanges, but
volatility is not a factor for ADRs. Contrary to previous researchers on domestic securities,
Mayhew and Mihov (2004) and Bollen (1998) find no evidence that volatility declines as a result
of options listing. We likewise find that volatility does not decline in the period following the
option listing for ADRs.
We also test many of the implications from the general equilibrium model for the
introduction of options; as noted in Danielson and Sorescu (2001) their model predicts that
options listings are associated with both a negative underlying stock price reaction and with
increases in relative short interest. Their evidence is largely consistent with their model. Our
findings for price reaction are consistent with Danielson and Sorescu (2001); ADRs in general
suffer from diminishing prices around the introduction of options. However, short interest does
not increase in the period following option listing. This is clearly at odds with the evidence on
U.S. domestic securities, where relative short interest does increase after an option is listed. The
change in volume, positive price change, and the standard deviation of returns prior to the listing
all have a negative influence on returns around the option listing date. The price effect is
unrelated to previous capital raising by the ADR firms in the U.S. market or the legality of short
sales in the home country. We do find that the abnormal return for option listing is cross21
sectionally related to the change in relative short interest and the availability of puts in the home
country.
We examine the stock market reaction of options listing on ADRs whose home markets
have differing market structures regarding put options and short sales. Our results provide
additional evidence and support much of the existing literature on domestic option listings, with
a few noted exceptions. ADRs from countries in which put options are not available experience
larger price declines than otherwise. So, in an environment where short sale constraints vary
widely across firms, we find direct support for the contention that option listings provide relief
for investors who have negative sentiment about the stock and are subject to a short sales
constraint. However, it does not appear that option listing entities seek out companies for which
those constraints are stronger.
22
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Portfolio Management, 20, 75-82.
25
Table 1
Summary Statistics
Panel A: Market Data
Optioned
803,223.21***
589,650.39***
1.474***
Non-Optioned
383,107.06
167,064.19
1.189
Relative daily volume from 90 days before to 30 days before
the option listing
29.924***
11.521
Relative daily volume from 30 days before to 30 days after
the option listing
25.241***
10.615
Relative daily volume from 30 days after the listing to 90
days after the option listing
25.499**
11.219
Standard deviation of daily returns from 90 days before to 30
days before the option listing
0.0277
0.0270
Standard deviation of daily returns from 30 days before to 30
days after the option listing
0.0295
0.0291
Standard deviation of daily returns from 30 days after to 90
days after the option listing
0.0275
0.0261
Relative short interest in the month preceding the option
listing
0.0917
0.0699
Relative short interest in contemporaneous month of option
listing
0.0985
0.0842
Relative short interest in the month following the option
listing
0.0912
0.0786
Market capitalization
Volume
Beta
Panel B: Short Sales and Put Options in the Home Country
Short sales are legal
Short sales are not legal
Put options available for trading
Put options are not available for trading
Number of ADRs
674
125
Number of
ADRs with
options listed
159 (23.59%)
31 (24.8%)
629
170
141 (22.42%)
49 (28.8%) †
Panel A: the mean values of independent variables for optioned versus their non-optioned ADR matches. Market Capitalization
and Volume are reported as of 90 days prior to the option listing, where market capitalization is shown in $000s. Beta is calculated
using the Brown and Warner market model over the (-120,-20) window prior to the option listing. Relative daily volume is the
average daily volume per 1000 shares outstanding over the stated time frame. Standard deviation of returns is the standard
deviation of raw unadjusted daily returns. Relative short interest is the reported short interest in that stated month divided by
shares outstanding that month. Panel B: shows the home country status for put option availability and short sales legality at the
time of the option listing. The significance level reported is for a two tailed t-test that the mean of a variable for the optioned ADRs is
the same as the non-optioned ADRs. ***, **, * indicates significance at the 1%, 5% and 10% levels. Significance level is also
reported for a Chi-square test for the difference in proportions, † indicates significance at the 10% level.
26
Table 2
Determinates of Option Listing for ADRs
Model Specification
1
Intercept
-14.6343
(0.0001)***
Log of Market
0.9665
Capitalization
(0.0001)***
Change in Price
0.3307
(0.4186)
Beta
0.0675
(0.7401)
Standard Deviation
Relative Short Interest 3
Months Prior
Relative Short Interest 1
Month Prior
Change in Relative
Short Interest
Average Daily Volume
Relative Daily Volume
Change in Volume
Put
Short
Neither Put nor Short
Percent Categorized
Correctly
Number of Observations
Chi-Square
2
-14.6633
(0.0001)***
0.9698
(0.0001)***
0.3256
(0.4243)
3
-11.1950
(0.0001)***
0.8449
(0.0001)***
4
-11.4723
(0.0001)***
0.8423
(0.0001)***
0.0677
(0.7159)
0.0441
(0.8153)
0.0008
(0.1898)
0.0008
(0.1852)
0.0357
(0.0003)***
0.0364
(0.0003)***
0.0234
(0.8539)
-0.0519
(0.7005)
-0.0234
(0.5856)
-0.0003
(0.6635)
0.0394
(0.0038)***
-0.0588
(0.3505)
0.6491
(0.4958)
0.8880
(0.2581)
1.5491
(0.1493)
1.0291
(0.9383)
0.0232
(0.8547)
-0.0531
(0.6912)
-0.0227
(0.5952)
-0.0003
(0.6899)
0.0404
(0.0032)***
-0.0603
(0.3419)
0.6573
(0.4904)
0.9067
(0.2470)
1.5949
(0.1345)
76.7%
76.7%
76.7%
76.5%
220
34.37
(0.0006)
220
32.25
(0.0006)
246
35.65
(0.0001)
246
35.38
(0.0001)
-0.4972
(0.1783)
0.2028
(0.6571)
0.4345
(0.1937)
This table presents the parameter estimates for a Logit model of option listing for ADRs. The dependent variable is either 1 if an
option was listed or 0 if was not. The model is estimated on the population of ADRs that are optioned and an equal number of nonoptioned ADRs. For each optioned ADR, a matching firm was chosen based on country of origin and market capitalization 90 days
prior to the option listing. Log Market Capitalization is calculated as the natural log market capitalization (in $000s) 90 prior to the
option listing. Beta is calculated using the Brown and Warner market model over the (-120,-20) window prior to the option listing.
Other independent variables are: the standard deviation of daily returns is calculated from -90 days to -30 days relative to option
listing, the relative short interest (short interest/shares outstanding) 1 month and 3 months prior to option listing. Change in relative
short interest is calculated from 9 months prior to 3 months prior to the listing date. Average daily Volume is calculated from 90
days prior to 30 days prior the option listing. Relative Daily Volume is average daily volume per 1000 ADR shares outstanding. The
percentage change is calculated from 9 months prior to 3 months prior the option listing. Put and Short are indicator variables for
whether or not put options or short sales are allowed on the home country at the time of the option introduction. Neither Put nor
Short is also an indicator variable for whether neither options nor short sales are allowed on the home country. P-values are
reported in parentheses. . ***, **, * indicates significance at the 1%, 5% and 10% levels.
27
Table 3
Stock Price Reactions for the Full Sample and the Matched Pairs
Panel A: Optioned and Matching ADRs
Number of
Observations
Optioned ADRs (all)
Optioned ADRs (with matches)
Matching ADRs
Number of
Observations with
Returns Data
Cumulative
Abnormal Return
166
158
176
-0.63%
-0.59%
0.29%
190
177
177
Panel B: One to One Match Between Optioned and Matching ADRs
Number of
Number of
Observations
Observations for
matched pair
Cumulative
Abnormal Return
P value
(0.0275)**
(0.0321)**
(0.0680)*
P value
Optioned ADRs
177
157
-0.59%
(0.0382)**
Matching ADRs
177
157
0.06%
(0.1073)
Cumulative
Abnormal Return
P value
Panel C: Optioned ADRs by Characteristics of the Home Country
Number of
Number of
Observations
Observations by
group
Puts
No Puts
157
116
41
-0.92%
0.58%
(.0693)*
(.4683)
Shorts
No Shorts
157
131
26
-0.60%
-0.19%
(.1168)
(.2893)
Panel A: reports the number of optioned ADRs, the number of optioned ADRs and their matches based on same country or origin
and market capitalization. Also shown is the number of ADRs and matches with data sufficient to calculate an abnormal return via
the Brown and Warner market model. For all three categories cumulative abnormal returns are reported for the window spanning 5
days prior to 1 day after the option listing, as well the as the p-value for a simple t-test for significance from zero. Panel B: shows
the only the one to one match were both the optioned firm and its match have sufficient data to calculate abnormal returns. Panel
C: shows the separates sub-samples (from Panel B) of optioned firms by those that did and did not have put options available for
trading in the home country and those that did and did not have short sales allowed in the home country at the time the option was
listed. All P-values are reported in parentheses for a simple t-test that the abnormal returns are different from zero. ***, **, *
indicates significance at the 1%, 5% and 10% levels.
28
Table 4
Country Specific Abnormal Returns for Optioned ADRs and Matches
Country of Origin
Argentina
Australia
Belgium
Brazil
Cayman Islands
Chile
China
Denmark
Finland
France
Germany
Hong Kong
India
Indonesia
Israel
Italy
Japan
Luxembourg
Mexico
Netherlands
New Zealand
Norway
Peru
Republic of Ireland
Russia
Singapore
South Africa
South Korea
Spain
Sweden
Switzerland
Taiwan
UK
Venezuela
Total
Number of
Matched
ADR pairs
5
2
1
4
8
4
5
1
1
11
2
3
7
2
2
4
9
3
16
5
1
2
1
5
2
2
3
2
6
2
2
4
29
1
157
Cumulative
Abnormal Return
for Optioned Firms
0.0004
-0.0252
-0.0213
-0.0045
-0.0046
0.0271
-0.0030
-0.0295
-0.0372
-0.0141
-0.0752
0.0216
0.0139
-0.0214
0.0083
0.0029
-0.0271
-0.0413
0.0229
0.0047
0.0162
0.0263
-0.0340
0.0200
-0.0468
-0.1016
0.0448
-0.0131
-0.0244
0.0114
-0.0195
-0.0406
-0.0104
-0.0055
Cumulative
Abnormal Return
for Matching Firms
-0.0055
-0.0056
0.0347
0.0074
0.0077
-0.0413
0.0053
0.0158
-0.0801
-0.0069
0.0082
0.0637
0.0411
-0.0237
-0.0397
-0.0094
-0.0357
0.0025
0.0214
-0.0032
0.0047
0.0265
-0.0458
0.0669
-0.0365
-0.0734
0.0397
0.0302
0.0028
-0.0319
-0.0085
0.0087
-0.0119
0.0107
Difference in
Means within
Country (p value)
(0.9077)
(0.4517)
n/a
(0.8216)
(0.6941)
(0.2962)
(0.8834)
n/a
n/a
(0.8263)
(0.4348)
(0.5899)
(0.4780)
(0.8404)
(0.3784)
(0.3190)
(0.8564)
(0.4309)
(0.9671)
(0.7086)
n/a
(0.9883)
n/a
(0.6484)
(0.4233)
(0.4293)
(0.9566)
(0.6109)
(0.1301)
(0.4807)
(0.7517)
(0.5395)
(0.9387)
n/a
This table shows the cumulative abnormal returns for the optioned ADRs and their matches, reported by country. CARs are
reported for an event window spanning 5 trading days prior to the listing to 1 trading day after the listing. P-values are reported in
parentheses for a difference in means test between the cumulative abnormal returns between the optioned ADRs and the nonoptioned matches. ***, **, * indicates significance at the 1%, 5% and 10% levels.
29
Table 5
Cross Sectional Analysis of Cumulative Abnormal Return for optioned ADRs
Model
1
2
3
4
5
Specification
Intercept
0.0421
0.0422
.0353
0.035
.0346
(0.070)*
(0.068)*
(0.100)*
(0.1070)
(.1050)
CRBO
0.0181
0.0181
0.0170
(0.359)
(0.356)
(0.383)
Pos. Price
-.0356
-0.0356
-0.0326
-0.0305
-0.0302
Change
(.0848)
(0.083)
(0.106)
(0.127)
(0.130)
Change in
-0.0203
-0.0203
-0.0243
-0.0264
-0.0285
Price
(0.331)
(0.327)
(0.227)
(0.187)
(0.1450)
Change in
0.0009
0.0009
0.0009
0.0009
0.0010
RSI
(0.068)*
(0.066)*
(0.057)*
(0.054)*
(0.050)**
RSI 1 Month
0.0061
0.0061
0.0058
0.0060
0.0060
Prior
(0.138)
(0.135)
(0.157)
(0.139)
(0.198)
Standard
-0.8353
-0.8353
-1.2056
-1.1333
-1.2129
Deviation
(0.247)
(0.245)
(0.033)**
(0.044)**
(0.027)**
Beta
-0.0102
-0.0102
(0.407)
(0.405)
Relative
-0.0003
-0.0003
-0.0002
-0.0002
Daily Volume (0.227)
(0.224)
(0.317)
(0.441)
Change in
-0.0128
-0.0128
-0.0135
-0.0144
-0.0159
Volume
(0.063)*
(0.062)*
(0.048)**
(0.032)**
(0.015)**
Put
0.0406
0.0407
0.0369
0.0365
0.03514
(0.049)**
(0.046)**
(0.062)*
(0.064)*
(0.073)*
Short
0.0009
(0.978)
Number of
105
105
105
105
105
observations
R2
0.2709
0.2709
0.2655
0.2596
0.2550
6
7
.0400
(.0580)*
.0503
(.008)***
-0.0336
(0.090)*
-0.0200
(0.285)
0.0008
(0.078)*
-0.0472
(0.002)***
-1.1793
(0.027)**
-1.3468
(0.011)**
-0.0144
(0.024)**
0.0352
(0.082)*
-0.0139
(0.029)**
0.0339
(0.085)*
105
105
0.2420
0.2331
0.0008
(0.081)*
This table shows the cross-sectional analysis of cumulative abnormal returns around listing date of an option for an ADR. The
dependent variable is the cumulative abnormal return upon announcement of an option listing (from Table 3 Panel B). The
independent variables are CRBO: an indicator variable equal to one if the company raised capital through an ADR prior to the option
listing, Pos. Price Change: an indicator variable to signify whether the change in price before the option listing (from 9 months prior
to 3 months prior) was positive, Change in Price: the percentage change in the ADR’s price per share from 9 months to 3 months
prior to the option listing, Change in RSI: is the change in relative short interest from month -3 to month -1 relative to the listing,
Standard Deviation: is the standard deviation of daily returns from -90 days to -30 days relative to the listing, Beta: is from the
market model regression used to calculate the cumulative abnormal returns (from Table 3 Panel B), Relative Daily Volume: average
daily volume of the ADR from -90 to -30 days relative to the listing, per 1000 shares outstanding over the stated time frame,
Change in Volume: from -9 months to -3 months relative to the listing, Put: an indicator variables equal to one if put options are
allowed in the home country 0 otherwise, : Short: an indicator variable equal to 1 if short sales were legal in the home country at the
time the option was listed for the ADR and 0 otherwise. All P-values are reported in parentheses. ***, **, * indicates the coefficient is
significantly different from zero at the 1%, 5% and 10% levels.
30