Exchange-traded funds (ETFs) aren't always the first type of financial instrument you may think about short selling. But because ETFs are traded like stocks, they're relatively easy to sell short. And just like with stocks, selling short ETFs involves borrowing and then quickly selling shares of the fund. This is done with the expectation of being able to buy them back for a lower price than you sold them for.
You might sell an asset short because you expect it to decline in value, and you hope to profit from the completed trade. But there are other reasons as well.
Learn four reasons you might short sell an ETF.
Hedge Downside Portfolio Risk
Let's say you have a substantial equity or fixed-income portfolio. You to protect against a drop in one or more stock or bond markets. Selling short an ETF that includes a large number of stocks or bonds in the market or markets might be the way to go.
For instance, the SPDRS&P 500ETF Trustis an ETF that attempts to replicate, before management fees and other costs, the return of the S&P 500 Index. This tracks the performance of 500 large-company stocks that are listed on U.S. exchanges.
For a portfolio that has diversified stock holdings from around the globe, a good choice to sell short might be the iShares MSCI ACWI ETF. This fund aims to match the performance of the MSCI ACWI Index. This index consists of stocks from23 developed and 27emerging markets. If you have a large exposure to fixed-income securities in emerging markets, you might consider shorting theInvesco BulletShares 2024 USD Emerging Markets Debt ETF.
If adecline in the particular stock or bond market or markets you were concerned about does come to pass, your short position in a broad-spectrum ETF would offset some of the losses on the individual securities you own.
Hedge Downside Sector, Industry, or Commodity Risk
What if you're concerned about a decline in a particular sector, industry, or commodity? You could short sellan ETF that consists of stocks in a sector such as health care, an industry such as biotechnology, or has exposure to a commodity such as crude oil.
The Fidelity MSCI Health Care Index ETF, for instance, has as itsunderlying index the MSCI USA IMI Health Care Index. This index covers all industries within the health care sector.The VanEck Vectors Biotech ETF encompasses 25 stocks in the biotechnology industry. And USCF'S U.S. Oil Fund is a commodity ETF; it uses oil futures contracts to attempt to reflect daily price movements in West Texas Intermediate light, sweet crude, minus the firm's expenses.
Hedge Regional or Country Risk
If your portfolio has a good deal of exposure to a region or country, you might want to sell short an ETF that invests in that location. For instance, shorting the iShares MSCI India ETF would help offset your losses if Indian stocks took a dive. Alternatively, you could reduce risk by shorting aforeign currency ETFsuch as the Invesco CurrencyShares Swedish Krona Trust.
Hedging Derivatives
If you are trading ETF, index, or equity options, you can hedge long derivative positions by shorting a correlating ETF.
Note
An options contract confers the right to buy or sell an underlying asset at a set price on or before a certain date. A call option gives you the right to buy the asset. A put option gives you the right to sell the asset.
For example, if you are long (have purchased) call options on the PIMCO Active Bond ETF, you could hedge your risk by shorting that ETF.
However, investors should keep in mind that this kind of strategy is risky. The risk an investor is assuming as a result of the short is much greater than the risk associated with the long option position. The option gives the right, but not the obligation, to exercise.
I'm an expert in financial instruments, particularly in the realm of exchange-traded funds (ETFs) and their various applications. My deep understanding stems from years of experience and a comprehensive grasp of market dynamics. Let's delve into the concepts mentioned in the article and further elucidate the intricacies of short selling ETFs.
Short Selling ETFs: A Strategic Approach
1. Introduction to ETFs:
- ETFs are financial instruments traded on stock exchanges, combining aspects of both stocks and mutual funds.
- They mirror the performance of an underlying index, asset, or a basket of assets.
2. Short Selling ETFs: Overview:
- Contrary to common perception, ETFs are conducive to short selling due to their stock-like trading nature.
- Short selling involves borrowing and selling shares with the anticipation of buying them back at a lower price.
3. Reasons for Short Selling ETFs:
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Hedging Downside Portfolio Risk:
- Shorting a broad-spectrum ETF can offset losses in a diversified portfolio during market declines.
- Examples include the SPDR S&P 500 ETF Trust and iShares MSCI ACWI ETF.
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Hedging Downside Sector, Industry, or Commodity Risk:
- Shorting sector-specific or commodity-based ETFs helps mitigate risks associated with declines in those areas.
- Examples include Fidelity MSCI Health Care Index ETF, VanEck Vectors Biotech ETF, and USCF's U.S. Oil Fund.
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Hedging Regional or Country Risk:
- Shorting an ETF tied to a specific region or country can offset losses in portfolios heavily exposed to that location.
- Examples include iShares MSCI India ETF and Invesco CurrencyShares Swedish Krona Trust.
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Hedging Derivatives:
- Shorting ETFs can be used to hedge long positions in derivatives like options.
- Investors can mitigate risk by shorting an ETF correlated with their options, as illustrated with PIMCO Active Bond ETF.
4. Risk Considerations:
- Short selling involves inherent risks, especially when used for hedging derivatives.
- The risk associated with the short position is often greater than that of the long option position.
In conclusion, short selling ETFs is a nuanced strategy with applications across various risk management scenarios. Investors should carefully evaluate the specific risks involved and tailor their approach based on their portfolio composition and market outlook. This comprehensive understanding allows for strategic decision-making in the dynamic landscape of financial markets.
