investment companies. ETF shares trade like common stocks or closedend
funds during market hours and can be purchased or redeemed like
open-end funds with an in-kind deposit or withdrawal of portfolio securities
at each day’s market close. In the United States, ETFs offer a unique
level of capital gains tax efficiency and in most markets they offer a high
level of intra-day liquidity and relatively low operating costs.
The trading flexibility and open-endedness of ETFs offer unusual
protection to short sellers.
1. It is essentially impossible to suffer a short squeeze in ETF shares. In
contrast to most corporate stocks where the shares outstanding are
fixed in number over long intervals,1 shares in an ETF can be greatly
increased on any trading day by any Authorized Participant.2 Creations
or redemptions in large ETFs like the S&P 500 SPDRs and the NASDAQ
100 QQQ’s are occasionally worth several billion dollars on a
single day. The theoretical maximum size of the typical ETF, given this
in-kind creation process, can be measured in hundreds of billions or
even trillions of dollars of market value. The open-ended capitalization
and required diversification of ETFs takes them out of the extreme risk
category. As a practical matter, “cornering” an ETF market is unimaginable.
The upside risk in a short sale is still theoretically greater than
the downside risk in a long purchase, but even that risk is modified by
the way ETF short selling is used to offset other risks.
2. Most ETF short sales are made to reduce, offset, or otherwise manage
the risk of a related financial position. The dominant risk management/
risk reduction ETF short sale transaction offsets long market risk with
a short or short equivalent position. Unlike the aggressive skier or
surfer, the risk manager who sells ETF shares short is nearly always
reducing the net risk of an investment position. In contrast to extreme
athletes, the risk managers selling ETFs short are more like the ski
patrol or lifeguards: They sell ETFs short to reduce total risk in a portfolio.
3. Most serious students of markets consider the uptick rule an anachronism
(at best). Requiring upticks for short sales is certainly unnecessary
and inappropriate for ETFs that compete in risk management applications
with sales of futures, swaps, and options—risk management instruments
that have never had uptick rules.
Read More : What Are The Most Important Safety Features Protecting ETF Short Sellers?
