With most major markets up in 2017, investors are using the major ETFs as beta hedges or outright risk positions for future volatility in stock prices.
The top five most shorted ETFs are index, region or product based. They are the Spider S&P 500 ETF (SPY US), iShares Russell 2000 ETF (IWM US), PowerShares QQQ (Nasdaq 100) ETF (QQQ US), iShares MSCI Emerging Markets ETF (EEM US) and the iShares iBoxx $ HighYield Corporate Bond ETF (HYG US). Rounding out the top ten are usually more specific sector, region and product based ETFs that change according to market conditions such as Financial Sector, Oil & Gas, VIX, U.S. Treasury and China-based ETFs.
Short interest in the top five most shorted ETFs increased by $20.6 billion, or 31%, in 2017 and increased by $13.8 billion, or 19% since the 2016 presidential election. More interesting is the ETF shorting behavior before and after the 2016 presidential election where short interest for the top five ETFs was unchanged from January 4th 2016 to November 8th, 2016, but decreased by $6.9 billion, or 9.4%, after the election. This signifies investors and portfolio managers expected a post-election rally and less volatility and took off almost a tenth of their hedges. Hedges came back on in 2017 as investors have become anxious trading in a rally that they see as technically suspect in its strength – or as traders refer to it, “the most-hated bull market, ever!” Even with the VIX trading at continued historical lows, short interest increased across every one of the top five shorted ETFs in 2017.
With most of the borrow rates for these ETFs at or near General Collateral, financing costs were relatively low, but their year to date mark to market P/L ended up being large due to the size of all of the positions and upward trend in the markets. In 2017, the net P/L for these five ETF shorts was a loss of $3.84 billion on an average aggregate short position of $74.2 billion for a return of -5.18%. If we go back to the election on November 8th, 2016, the total net of financing mark to market loss increased to a loss of $8.18 billion, on an average short position of $73.5 billion for a return of -11.12%.
The SPY ETF is by far the most shorted hedge vehicle worldwide with over three times the short activity of its nearest competitor and more short activity than the total of the next nine most-shorted ETFs all together. 2017 SPY short interest increased $12.4 billion, or 30%, and at $53.2 billion is slightly above its 2016 year to date average of $52.4 billion. 2017 IWM short interest is only up 20% for the year with a $2.8 billion year to date increase to $16.9 billion. Short activity in IWM has been climbing steadily since January, and we have to go back to November 2014, when IWM short interest was $18 billion, to see higher levels.
SPY and IWM are the only ETFs with short interest over $10 billion, and QQQ is a distant third at $6.1 billion. 2017 QQQ short interest is up $1.2 billion, or 26%, and has seen steady growth every month this year. EEM short interest is up 68% in 2017, the largest percentage increase of the top five, increasing from $2.2 billion to $5.5 billion. The last time EEM short interest was over $5.5 billion was in March 2014 when short selling levels climbed over $7 billion. The HYG ETF also had a significant move in 2017, up 61% for the year, increasing from $2.1 billion to $5.5 billion.
With the VIX trading at or near historic lows, most markets trading in positive territory for most of the year, the fed funds rate poised for two more increases this year and new presidential policies just starting to take hold, traders have increased their hedges via the major ETFs over the past few months after decreasing them coming into the end of 2016. If the VIX begins to trade up and markets see more turmoil for either political or economic reasons, we should see more short selling in the major ETFs as traders look to hedge beta risk out of their portfolios.
Short sellers have incurred over $3.8 billion in mark to market losses in the five major ETFs in 2017; with almost $90 billion of short exposure, it would only take a 4.5% drop in the markets to cover those losses. Otherwise, these short ETF positions continue to be an expensive insurance policy for traders that feel uneasy at what they consider the tail-end of an eight year rally. The last eight year rally, ending in 1996, saw an upward continuation for several years with stocks averaging a 20% return until the tech bubble burst in 2000. The previous eight year rally ended in 1987 with Black Monday and a year down 17%. The continuation of this eight year rally will not necessarily be binary but there is a chance that the hedges pay off in a big way if markets collapse or eat up a good chunk of alpha if the markets continue to rally.
For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC Ihor.Dusaniwsky@S3Partners.net
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