Hard To Borrow Stocks (Preview)

By Lawrence G. McMillan

In the past, we have occasionally talked about hard to borrow stocks, and how that affects option prices.  When market makers and others cannot borrow stock, then the “normal” option arbitrage relation falls apart.  Normally, the following equation holds true (modulo dividends and carrying charges):

Stock price = Strike Price + Call Price – Put Price (where put and call have the same terms)

Arbitrageurs involved in reverse conversions (reversal) can keep this in line by shorting stock, buying calls, and selling puts.  However, if the stock cannot be shorted, then there is a dearth of put sellers quite often.  That is, puts become expensive (and calls might become cheap as well).  

Consider the current situation in System1 Inc. (SST):

SST: 15
SST Apr (14th) 15 call: 0.70 bid, offered at 1.05
SST Apr (14th) 15 put: 4.20 bid, offered at 4.40

The put is tremendously overpriced.  If the stock could be borrowed, then rearranging the above equation,  we would have this formula for the put’s value:

Put Price = Strike Price + Call Price – Stock Price 
   = 15 + 1.05 – 15 = 1.05
Yet the put is trading at 4.20.  

Well, let’s just sell as many of those as we can, right?  That would be very aggressive, and clearly one wouldn’t want to sell too many of those...

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