Monthly Archives: November 2014

ETFs create shares for shorters to borrow; exponentiating downside

In many previous articles I have pointed to one particular previous post that attempts to explain why stocks (and ETFs) get drastically over sold.  I recently came across an article which pointed out that ETFs are able to create shares that traders can borrow to take short positions in the ETF, which in effect exacerbates the downside.

That’s because during times of stress, certain ETF dealers can create additional shares to satisfy demand for short sellers, who need shares to borrow and sell.
– Excerpt from this article

So not only are the underlying stocks being shorted, dragging down the price of the stock and therefore the ETF, but the ETF as a basket can be shorted itself with shares “created” out of thin air, exacerbating the down side (as well as the upside when a rally starts and shorts have to cover) in the ETF.

Read that excerpt from Barrons above again!  Not only can ETFs be shorted like regular stocks, but the EFT managers can, in times of stress, create EXTRA shares for shorters to sell, which creates exponential downward pressure on the value of the ETF.

This creates an opportunity for arbitrage, as the ETF, in the short term, differs from the value of the underlying total values of the funds individual stocks.

Like a stock, ETFs can be sold short. Those provisions are important to traders and speculators, but of little interest to long-term investors. But, because ETFs are priced continuously by the market, there is the potential for trading to take place at a price other than the true NAV, which may introduce the opportunity for arbitrage.
– Excerpt from this article

I believe this is happening right now to an absolute EXTREME in the metal miner ETFs like SIL, GDX, and GDXJ.

This is yet another reason to get in while these ETFs are getting hammered down as it all has to come flying back with a vengeance at some point.

At some point, when I get more time (yeah.. right!), I’d like to look further into what happens with the money that is made from lending those extra created shares for the shorters to sell, as a shorter has to pay a fee to borrow a stock/ETF to short.  I would think those fees should ultimately go to the fund increasing the value for those of us holding long term, but for me, it remains to be discovered what really happens to those fees.