SEC short-sale rule stifling US options trade

By Doris Frankel

CHICAGO (Reuters) - The U.S. clampdown on short selling has made it difficult for option market makers to maintain orderly trading and raised the cost of protecting investments at a time when options are most needed to weather the maelstrom on Wall Street.

The Securities and Exchange Commission-directed ban on making bets that financial stocks will fall was part of the government's coordinated effort to stabilise the U.S. financial sector. It came after several U.S. bank failures and fears of economic recession.

The ban on the short selling of more than 950 financial stocks, which will be lifted on Wednesday night, has already hindered the growth in the U.S. options market because it raised transaction costs for customers, placed a burden on option market makers and reduced volume.

Investors have found the cost of protection has shot up as bid/ask option spreads become wider in many financial stocks.

"The current restrictions have removed every option strategy in the market that relies on short selling and the options liquidity provided by it," said Joe Corona, director of strategic planning at LiquidPoint, which is part of BNY ConvergEx Group, an options broker-dealer in Chicago.

"This has reduced volume and widened spreads."

Short sellers sell borrowed shares with the aim of buying them back at a lower price and returning it to the lender.

Although option market makers have been granted relief and are able to short stock, the more stringent requirements have made it harder for them to locate a financial stock to borrow. Lenders are now charging them higher fees for the privilege of borrowing the stock.