Short selling and options trading: A tale of two markets

Recent research documents both short selling and option volume are predictive of future real estate investment trust (REIT) returns, suggesting informed investors exploit their informational advantage in both the traditional equity and derivative security markets. However, little work has explicitly examined the factors influencing which of these markets informed investors choose to engage when transacting. We address this gap in the literature and find clear evidence that the risk associated with short selling is a significant driver of this decision. Specifically, using a sample of 124 unique equity REITS with both active short selling and option markets over the past 10 years, we find that when short selling is riskier, option volume is more predictive of future returns. These results suggest that investors view options as an alternative to shorting, and their decision to transact in the derivatives market is materially influenced by short-selling risk.