Do put warrants unwind short‐sale restrictions? Further evidence from the Taiwan Stock Exchange

• Published date: 01 March 2021
• Author: Yi‐Wei Chuang,Wei‐Che Tsai,Pei‐Shih Weng,Chi Yin
• Date: 01 March 2021
• DOI: http://doi.org/10.1002/fut.22169

J Futures Markets. 2021;41:325–348. wileyonlinelibrary.com/journal/fut © 2020 Wiley Periodicals LLC

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325

Received: 29 September 2020

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Accepted: 4 October 2020

DOI: 10.1002/fut.22169

RESEARCH ARTICLE

Do put warrants unwind short‐sale restrictions? Further

evidence from the Taiwan Stock Exchange

Yi‐Wei Chuang

1

|Wei‐Che Tsai

2,3

|Pei‐Shih Weng

2

|Chi Yin

2

1

Department of International Business,

Feng Chia University, Taichung,

Taiwan, ROC

2

Department of Finance, National Sun

Yat‐sen University, Kaohsiung,

Taiwan, ROC

3

Risk and Insurance Research Center,

National Chengchi University, Taipei,

Taiwan, ROC

Correspondence

Pei‐Shih Weng, Department of Finance,

National Sun Yat‐sen University, No. 70

Lien‐hai Road, Kaohsiung 80424, Taiwan,

ROC.

Email: psweng@g-mail.nsysu.edu.tw

Abstract

This study investigates the relationship between stock short‐selling restrictions

and bearish equity warrants on the Taiwan Stock Exchange to clarify the

substitutive role of put warrants for underlying stocks subject to short‐sale

constraints. We show that put warrant transactions increase when short selling

is prohibited in the spot market and the substitutive increase in trading also

leads to wider bid–ask spreads and higher implied volatility for put warrants.

Moreover, we find that the increased trading activities in put warrants could

subsequently affect spot market trading through warrant issuers' required

dynamic hedging behaviors.

KEYWORDS

bid–ask spreads, implied volatility, put warrants, short‐sales restrictions, short‐selling ban

1|INTRODUCTION

When an equity market is subject to short‐sales constraints, the stock short positions are not conductible and investors

must seek alternative assets to hedge, realize their pessimistic viewpoints in trading, and arbitrage their private

information predicting a negative market impact. This study examines whether bearish equity‐linked securities can

serve as substitutes for stock short selling. We are particularly interested in equity put warrants, which have received

less attention in prior studies. Though the association between bearish equity derivatives and stock short sales has been

examined in the literature, prior studies focus more on equity options and the findings are mixed. For example,

Figlewski and Webb (1993) argue that investors with short‐sale constraints buy put options as substitutes for selling

stocks directly. Danielsen and Sorescu (2001) show that the introduction of options trading can alleviate the inefficiency

of underlying stocks caused by short‐sale constraints. Mayhew and Mihov (2005) use firm size, short interest, and the

number of outstanding shares as proxies for implicit short‐sales restrictions and examine the impacts on the options

market. They find that the trading volume of bearish options does not increase when the stock market is subject to

short‐sale constraints, indicating that the bearish option does not serve as an alternative short‐selling instrument.

In a more recent study, Grundy et al. (2012) examine whether put options served as substitutes for short sales during

the September 2008 short‐sale ban in the US stock market. They find that put options volume underwent a significant

diminution during the ban period. Hao et al. (2013) show that short sales tend to be more effective in reflecting bad

news information than put options when traders are informed. Given their higher leverage, trading put options is

theoretically more profitable than short‐selling stocks; the findings of Hao et al. (2013), however, imply that investors

still prefer stock short selling and do not consider put options to be substitutes.

This study's research question is, can individual stock warrants—the active equity‐linked derivatives particularly in

Asia‐pacific countries—serve substitutes for short selling in the stock market? Focusing on the Taiwan Stock Exchange

(TWSE), one of the leading emerging security markets where equity warrants trading is growing rapidly, we examine

the relationship between short selling and bearish warrant trading. Related research (e.g., Blau & Brough, 2015; Blau &

Wade, 2013; Chen et al., 2019; DeLisle et al., 2016; Li et al., 2016; Lin & Lu, 2016) largely focuses on put options trading

because of the flourishing equity options market in the United States. By contrast, in Taiwan and many other Asian

markets, such as Hong Kong and South Korea, the equity warrants market is much more liquid and popular than the

equity options market, making put warrants more attractive than options to hedgers and speculators in Asian markets

and allowing us to examine the information role of these less‐explored bearish equity‐linked derivatives.

1

,

2

In addition, focusing on warrants rather than options is more suitable for examining the substitution effect of

equity‐linked securities. In the United States, options are traded in the futures exchange while, in Taiwan, equity

warrants are traded in the stock exchange. If investors really view equity‐linked derivatives as alternative instruments

for short selling, the substitutes in the same exchange, for example, stock warrants, should be considered first to avoid

latent frictions in searching cross‐market instruments. In this regard, put warrants should be more convenient short‐

selling substitutes than put options.

Furthermore, the mechanism of the Taiwanese stock market is more suitable than that in the United States for

examining the influence of bearish equity derivatives under stock short‐sale restrictions. In the United States, stocks are

usually traded without short‐selling constraints; therefore, restrictions are only implemented as bans for extreme

market statuses and their influence can be observed and examined for specific periods. For instance, Grundy et al.

(2012) analyze short‐sale constraints during the ban period caused by the 2008 financial crisis. On the contrary, before

2013, the selected stocks on the TWSE could be sold short directly when the rest of listing companies were regularly

subject to short‐sale restrictions. By taking advantage of these characteristics, our study can compare short‐selling‐

restricted stocks and short‐selling‐unrestricted stocks for all available trading days over a relatively long period rather

than merely focusing on a specific period of time, thereby generating more insights.

As for studying the extraordinary effects resulting from specific events, for example, the global financial crisis,

analyses of Taiwanese samples also have an advantage over those from other countries. During the 2008 financial crisis

period, many countries adopted short‐selling bans with different ban settings (see, e.g., Beber & Pagano, 2013).

However, among major stock markets with active stock options/warrants trading, Taiwan was the only market to

launch a short‐selling ban for all stocks and the duration of the ban was much reasonable.

3

By comparison, US

regulators banned short sales only for specific financial stocks from September 19 to October 8, 2008. In Asian markets,

South Korea banned all stocks beginning in early October 2008, but the prohibition lasted until June 1, 2009, which is

longer than 8 months. Similarly, Japan banned all stocks beginning on October 30, 2008, and the ban remained in place

even longer, lasting until after mid‐2009.

4

The short‐selling ban implemented on the TWSE during the financial crisis period is an ideal experiment for testing

the substitution effect of bearish equity‐linked securities for two reasons. First, if a short‐sale ban is not for all stocks,

investors can still find other unrestricted and closely related companies to sell short instead of purchasing put options or

warrants directly. Only comprehensive short‐sale bans on all stocks in a market can force investors to seek alternative

instruments for equity short selling. Second, if a ban is long‐lasting, rather than simply remaining in the derivatives

market for their short‐selling substitutes in the local market, investors will likely consider moving their transactions to

other stock markets without short‐sale constraints. When investors expect that a short‐selling ban is temporary, they are

more likely to stay in the same market and look for trading substitutes that concur with the constraints. Conversely, if

investors do not expect the trading ban to terminate soon, they will be compelled to leave for other unrestricted stock

markets, which would make examining their substitutive trading behaviors difficult.

Another factor that distinguishes our research from prior studies is that in addition to the substitution effect

between put warrants and stock short sales, we test the impact of stock short‐sale restrictions on bid–ask spreads and

the implied volatility of put warrants—aspects that previous studies have not explored. If put warrants do serve as

substitutes for short selling, we expect that increased warrants volume will lead to wider bid–ask spreads and higher

volatility. The spread of an asset is generally interpreted as an indicator of the uncertainty and information asymmetry

1

Hong Kong, Taiwan, and South Korea are usually the top three warrants markets in the Asian region. In 2015, Hong Kong, Taiwan, and South Korea

were ranked as the Nos. 1, 5, and 6 warrants markets in the world.

2

Li and Zhang (2011) find that derivative warrants typically have higher prices than otherwise identical options in Hong Kong, and the price

difference reflects the liquidity premium of derivative warrants over options. Newly issued derivative warrants are much more liquid than options

with similar terms.

3

The ban started from September 22, 2008 to the end of 2008.

4

Hong Kong has very active equity warrants market, but it did not launch any short‐selling ban in the stock trading for the 2008 financial crisis.

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