Economics and Market Effects of ETF Short Selling
He who sells what isn’t his’n, Must buy it back or go to prison.
—Attributed to Daniel Drew
Most readers of this book will rarely, if ever, consider selling shares of an ETF short as part of their investment program. However, short selling in the ETF marketplace is a large part of ETF trading volume, and ETF short positions are often so large relative to total ETF shares outstanding that the investor who does not understand the effects of short selling on his ETF position risks (1) paying unnecessary taxes on ETF dividends, (2) misunderstanding the significance of ETF market statistics, (3) missing the best way to take some positions, and (4) missing some unusual but attractive investment opportunities. Before we address these problems and opportunities, it is useful to take a careful look at the risks associated with selling ETFs short, in order to put things in perspective.
UNDERSTANDING THE RISKS OF SELLING ETFs SHORT
Anyone who has wandered by video monitors in the windows of a ski or surf shop has seen dramatic pictures of skiers or surfers in obvious peril. A skier jumps from the edge of a cliff above the camera and disappears from view with no apparent chance of survival—until the scene cuts to another camera showing a safe landing on a 55-degree slope. At the surf shop, a surfer dude—or, with increasing frequency, a surfer girl—is tucked in the curl of a six-story wave headed for shore. Both skier and surfer ...