Short Interest Is Soaring in These ETFs

For many investors, the standard of use of exchange-traded funds (ETFs) is as a buy-and-hold investment, but some professional traders go a different direction. Some broad market and sector ETFs generally viewed as buy-and-hold instruments are often heavily shorted by professionals.

Professional traders employ strategies such as being long a technology stock – say Apple Inc. (AAPL) – while hedging that exposure with a short position in a technology sector ETF. The liquidity, tight spreads and often low costs to borrow found on major broad market ETFs such as the SPDR S&P 500 ETF (SPY) are among the reasons pros turn to ETFs for bearish exposure. (See also: 4 Strategies to Short the S&P 500 Index.)

"Most ETF short sales are made in essentially cap-weighted benchmark index ETFs and they are used to reduce, offset, or otherwise manage the risk of a related financial position," according to Fidelity. "The dominant ETF short sale transaction offsets all or part of the market risk of a related long position. The upside risk of any short sale is theoretically greater than the downside risk of a (long) purchase, but the upside risk of the short position is reduced by the way most ETF short sales are used in arbitrage-type transactions to offset other risks."

In fact, SPY, the iShares Russell 2000 ETF (IWM) and the Invesco QQQ (QQQ), the Nasdaq-100 tracking ETF, are almost always the three most shorted ETFs in the U.S. That is the case today, but as recent data from S3 Partners indicate, traders boosted bearish bets in some other well-known ETFs during the week that ended Feb. 16. QQQ and IWM, which is the largest ETF tracking small-cap stocks, saw the largest increases in short interest last week at $1.34 billion and $566 million, respectively, in new short activity, according to S3 Partners data. (For more, see: The Basics of Short Selling.)

Bearish on Bonds

Data also confirm that short interest is rising in some big-name corporate bond ETFs, including both investment-grade and junk fare. On a combined basis, short interest in the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) jumped by $900 million last week, according to S3. LQD is the largest corporate bond ETF, while HYG is the largest junk bond ETF.

At least one emerging markets bond ETF saw a jump in short interest as well. The iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB), the largest emerging markets debt fund of any kind, saw a short interest increase of $178 million for the week that ended Feb. 16, according to S3. Traders could be targeting EMB on expectations that the U.S. dollar is poised to rebound. A stronger dollar can lead to higher external financing costs for emerging markets issuers on dollar-denominated debt, which EMB holds. (For more on this ETF, check out: EMB: iShares JPMorgan USD Emerging Markets Bond ETF.)

Not Just EMB

EMB is not the only emerging markets ETF attracting fresh bearish bets. Last week, traders upped short interest in the iShares Core MSCI Emerging Markets ETF (IEMG) and the iShares MSCI Emerging Markets ETF (EEM) by $289 million and $152 million, respectively, according to S3 data. Traders could be using short positions in diversified emerging markets ETFs to hedge long exposure in single-country funds or individual emerging markets stocks. Year to date, the largest China, Russia and South Korea ETFs, as three examples, have hauled in almost $700 million on a combined basis. (For additional reading, check out: Emerging Markets ETFs: New ESG Frontiers.)