The impact of position limits on options trading

•We provide new evidence of how regulatory position limits on financial derivative contacts affect the volatility and pricing efficiency of the underlying spot contract.•We look at option trading behavior and S&P 500 returns and volatility behavior in the period surrounding the suspension of trading limits for ETFs on the S&P 500 (SPY contracts) in the pilot program (amendment to CBOE rule 4.11), whereby position limits were temporarily suspended.•We find that the removal of position limits during the pilot period did not harm markets in terms of volatility.•We also find that during the pilot period, price efficiency improved, based on market tracking performance of the ETFs. We provide new evidence on the effects of position limits on options for ETFs on the S&P 500 (SPY contracts), based on market reactions to the pilot program (amendment to CBOE Rule 4.11), whereby position limits were temporarily suspended. Removal of position limits during the pilot period did not harm the underlying markets in terms of volatility. While option volume shocks enhance SPY return volatility shocks, these effects are alleviated when position limits are suspended. Furthermore, during the pilot period, price efficiency improved, based on the market tracking performance of the ETFs.