Semiconductors, biotech, retailers, natural gas, Mexico and junk bonds—those are some of the areas that traders are betting against, according to ETF.com’s latest list of most-shorted ETFs.
“Shorting” is the process of borrowing a security, selling it immediately and then buying it back at a later date―preferably at a lower price. If done correctly, shorting is way to profit from a decline in the price of a security.
Of course, it doesn't always work out according to plan. If a security you shorted increases in price instead, you'll have to buy it back at a higher price than you sold it at, resulting in losses. Theoretically, there's no limit to how big those losses can be, because there's no limit to how high a security’s price can climb.
That's in contrast to a security bought normally, where "zero" is the limit on the downside.
Risky Trading Strategy
It’s a risky strategy that can backfire—as anyone who put an outright short position on the VanEck Vectors Semiconductor ETF (SMH) at the beginning of the year is well-aware. SMH has returned 9% in 2018 on the back of a broader rally in the tech sector. It’s also the fund with the largest short interest percentage of all ETFs.
More than 20.2 million shares of SMH are being shorted, compared to 9.6 million total shares outstanding (it's possible to have a short interest greater than 100% because shares can be continually borrowed and shorted, indefinitely).
Sometimes short positions are hedges or part of a pair trade made by sophisticated investors. But in many cases, they are outright bearish bets against an ETF in expectation that prices will decline. When short interest is high, it may signal that traders are expecting a fall in the price of an ETF.
Given the nature of short selling, which requires a margin account and consistent monitoring of the position, it's typically only done by active traders with a high risk tolerance. Still, it's a popular method of betting against ETFs.
In addition to SMH, there are a few other ETFs that have more shares being shorted than there are shares outstanding. They are the SPDR S&P Retail ETF (XRT), the VelocityShares 3X Inverse Silver ETN (DSLV) and the iPath S&P 500 VIX Short-Term Futures ETN (VXX).
It’s not surprising to see XRT be a popular target for short-sellers. As consumers increasingly turn to online merchants to make their purchases, brick-and-mortar retailers have been losing business and shuttering their stores en masse.
Meanwhile, VXX is another unsurprising entry on the most-shorted list. The Cboe Volatility Index—better known as the VIX—is used regularly by hedgers and speculators to bet on and against volatility. VXX tracks VIX futures, meaning anyone who shorts it is effectively shorting the VIX.
Shorting A Short
Then there is DSLV, which is an inverse ETN and an interesting product to see on the most-shorted list.
Inverse products are another way to bet against areas of the financial markets. These ETFs take on the underlying short positions so traders can effectively "go short" by "going long" these products. It's a simpler process for those who don't want to (or can't) do the shorting themselves.
On the surface, it’s puzzling: Why would anyone short an inverse product?
But it makes sense when you consider that inverse products―and especially leveraged, inverse products―suffer from performance drag due to periodic (usually daily) rebalancing.
For some volatile products, that performance drag can be crippling. Take the VelocityShares 3X Inverse Natural Gas ETN (DGAZ), another product on the most-shorted list; it's down a whopping 90% since its inception.
There is a total of seven leveraged or inverse products out of the 20 most shorted ETFs. In addition to the ones already mentioned, there are the Direxion Daily Energy Bear 3X Shares (ERY), the Direxion Daily Gold Miners Index Bear 3x Shares (DUST), the Direxion Daily Junior Gold Miners Index Bear 3X Shares (JDST), the VelocityShares Daily 2x VIX Medium-Term ETN (TVIZ) and the VelocityShares 3X Long Natural Gas ETN (UGAZ).
Betting Against Biotech & Housing
Turning back to the more vanilla products, there are some notable ETFs that short-sellers are betting against.
The SPDR S&P Oil & Gas Exploration & Production ETF (XOP) and the United States Natural Gas Fund LP (UNG) are two funds with short interest percentages above 80%.
The SPDR S&P BIOTECH ETF (XBI) stands alone as the only health-care-related fund to be targeted heavily by short-sellers.
Finally, there’s the iShares MSCI Mexico ETF (EWW) (a trade war play), and the iShares iBoxx USD High Yield Corporate Bond ETF (HYG) and the Utilities Select Sector SPDR Fund (XLU) (two interest-rate-sensitive funds) that short-sellers are betting against.
For a full list of the most-shorted ETFs, see the tables below:
20 Most Shorted ETFs
Source: Bloomberg; data as of July 24, 2018