Does Option Trading Affect the Return Predictability of Short Selling Activity?

We analyze the effect of option trading on the return predictability of short interest. There is no difference in the return predictability of short-interest ratios between stocks with and without traded options. The predictability of the put-call open interest ratio (PCOIR) is weaker than that of the short-interest ratio (SIR), which does not change after controlling for the PCOIR. While the predictability of the SIR lasts twelve months, the predictability of the PCOIR disappears after the first month. Both the expected and unexpected components of the SIR can predict stock returns, which suggests that the return predictability of short interest is related to both short-sale constraints and information discovery. In contrast, only the unexpected component of PCOIR, not the expected component, can predict stock returns.