ETF Short Interest Drops from High March 2004 Levels

July 03, 2004

Compared to ordinary equity short volumes, ETF have phenomenally high short interest for a variety of hedging and speculative reasons. What the latest drop in short interest may mean...
If the level of ETF short interest is any indication of market sentiment, investors have become less bearish since March, when the level of ETF short interest was an estimated 25.7%, as a percentage of shares outstanding. As of June 15, it decreased to 20.5%, according to new research from Deborah Fuhr at Morgan Stanley. 

 

Most of this ETF short interest is held by large institutions, who like ETFs as shorting vehicles for several reasons.

Unlike normal securities, ETFs are exempt from the up-tick rule - ETFs also have very thin expense ratios.  Additionally, ETFs allow investors to short indexes that may not be covered by derivatives.

Date

Short interest (# of shares)

% of shares outstanding

 

S&P 500 index levels

Jan 2004

641,038,345

24.8%

1,132.1

Feb 2004

667,141,017

24.8%

1,157.0

March 2004

715,449,593

25.7%

1,104.5

April 2004

604,514,973

21.1%

1,128.2

May 2004

620,910,994

21.0%

1,095.7

June 2004

613,819,213

20.5%

1,132.0

Source: Morgan Stanley ETF Strategies, the AMEX, and Bloomberg.

Short interest data id captured for U.S. listed securities on the 15th of each month or the next business day and reflects the number of shares that have yet to be repurchased to give back to lenders.

As of June 15, a long-term bond ETF was the most-shorted fund in terms of short interest as a percentage of shares outstanding.  The iShares Lehman 20+ Year Treasury Bond Fund had a whopping 192% of shares outstanding in short interest.

 

ETF

Symbol

% of shares outstanding

Short interest (# of shares)

The iShares Lehman 20+ Year Treasury Bond Fund

TLT

192.17%

10,569,304

Financial Sector SPDR

XLF

133.46%

39,514,017

iShares Russell 2000

IWM

78.27%

37,100.903

iShares Real Estate

IYR

73.93%

4,103,215

DJ Transportation

IYT

73.82%

332,206

DJ STOXX 50

FEX

50.23%

979,519

Nasdaq-100 Cubes

QQQ

47.50%

277,564,204

DJ Global Titans

DGT

46.54%

395,599

iShares GS Software

IGV

41.16%

1,276,009

Value Index VIPERs

VTV

40.48%

446,076

 

ETF Shorting Strategies

Investors who short company or ETF shares are essentially betting that the price will go down, since they are borrowing shares and selling them, hoping they can buy them back later at lower price and return the shares to the lender at a profit.

Although ETFs can be used to make a speculative "naked" bet on falling prices, most sophisticated investors short ETFs as part of conservative hedging strategies.  For example, an long investment in the S&P 500 can be hedged by shorting either of the ETFs that track the benchmark - the SPDR 500 (ticker: SPY) or the iShares S&P 500 (ticker: IVV).

There are also broad international ETFs that are good vehicles for hedging exposure abroad.

"For instance, the iShares MSCI EAFE (ticker: EFA) and the iShares MSCI Emerging Markets Free (ticker: EEM) can be used to hedge global exposure," wrote Fuhr in her report.  "Investors can take advantage of their ability to short country, regional or global exposure through these ETFs - even on down-ticks - to establish a hedge."

Index-linked ETFs are also ideal choices for long/short strategies and relative value plays.

"If a portfolio manager believes that S&P small cap companies will outperform large cap companies, the manager can use ETFs to position the portfolio to reflect expectations," wrote Fuhr.  "By shorting S&P 500 SPDR  and going long the S&P Small Cap iShares (ticker: IJR), the position is established.  ETFs could have been used to capture this return."

Similar strategies can be used to capture relative outperformance in growth and value styles, said Fuhr.

There are 134 U.S.-listed ETFs to choose from with over $165 billion in total assets, according to the latest figures from the Investment Company Institute.

*****

John Spence is editor of IndexUniverse.com. Check out his musings on the ETF industry each Monday at CBSMarketWatch.com. If you have ETF story ideas, contact him at [email protected]. Also contact him if you have an article submission for The Journal of Indexes -- or if you're a financial reporter wishing to interview Steven Schoenfeld on his upcoming book Active Index Investing.

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