Why Is The SPDR Retail ETF (XRT) 600% Short?

June 10, 2011

Watching flows in and out of XRT and its monster short position might give investors pause. It shouldn’t.

 

If ever there was a security that highlights the difference between traders and long-term investors, then the SPDR S&P Retail ETF (NYSEArca: XRT) is it. XRT is somewhat famous in ETF circles. It’s often the most heavily shorted ETF in the market.

In fact, as of the latest data, it’s 626 percent short—a number that borders on mythological. But it’s actually not so unusual for ETFs, where creation, redemption and settlement-timing mismatches can create seemingly impossible data like that.

But even though XRT’s short interest seems high, it’s surprisingly consistent.

 

XRT Short Interest

 

Since that spike in mid-2009, between 60 million and 80 million shares of XRT have more or less been notionally short. But remember, short interest reporting is incredibly buggy, and not timely. It’s self-reported information produced every two weeks, with a lag. So you can’t look at the end of this chart and say “aha!” as short interest has gone up.

It’s also possible that the short interest represents shares that may in fact simply not yet have been created for delivery by market makers. If a market maker sells 1 million shares of XRT it doesn’t actually own, it doesn’t have to actually do the creation to make good on that delivery for five days. More than likely, however, the market maker is completely hedged by buying and holding the underlying basket while maintaining his short position in the ETF. More on that in a minute.

XRT showed up on my screen again in the past few weeks because we track the daily ETF fund flows at IndexUniverse, and the action inside XRT has been head-scratching. Here are the shares outstanding for XRT over the past month:

 

XRT Flows

 

What the blue line tells us is that investors—or rather, authorized participants—doubled the size of XRT within a few days through creations, and then quickly bought shares of XRT off the secondary market to redeem.

 

 

It would be easy to read too much into this chart. That little pop over $54 in the fund’s NAV on May 31 could be related to the 3.35 million shares created that day. But honestly, while $175 million is a lot of money for an asset manager, in the grand scheme of things, it’s nowhere near enough to move the basket of 100 retail stocks APs needed to purchase on the day. More buyers than sellers help to move prices, but there’s no tail wagging the dog here. Barnes & Noble, the fund’s largest holding at 1.72 percent, trades $50 million worth of stock every single trading day. An extra $3 in volume surely matters, but it’s definitely not driving the bus.

Instead, what’s happening here is people are making broad speculative trades, and then pulling them.

So, if you’re an AP in XRT, how do you handle this? If you’ve sold that 1 million shares, do you really feel like you need to go roll up that position early, given that it’s highly likely there’ll be a redemption tomorrow that balances your book? Sure, you’ll make the offsetting trade to hedge your position -- buying up all the actual retail stocks so you’re not actually short the retail sector as naked exposure. But will you bother to go to State Street and do the create, pay the transaction costs, knowing there’s a good chance you’ll just be back tomorrow to do the opposite trade?

Of course not.

For investors, all these intramarket shenanigans are actually meaningless, but have a nasty tendency to clog up the headlines. As an investor, all I care about is whether XRT delivers on its core promise to investors, and it does that in spades. The fund hasn’t traded to a significant premium or discount to its NAV in years.

 

XRT Premium

 

In fact, all of this back and forth in creation and redemption is the reason it’s traded at ever-narrower and narrower premiums and discounts.

It is, in fact, the whole point of creation and redemption activity.

 

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