Wednesday, September 24, 2008

How the short ban is affecting short ETFs

Excerpt from the Wall Street Journal:


The short-sale ban has been particularly troublesome for some ETFs that let investors bet against financials. Rydex Investments and ProShare Advisors said Friday said they would temporarily halt the creation of new shares for several of these ETFs. Trading in the three ETFs -- Rydex Inverse 2x S&P Select Sector Financial, Short Financials ProShares and UltraShort Financials ProShares -- was halted for part of the day Friday.


The companies decided to suspend creation of new ETF shares amid concerns about their ability to get the swap agreements and other instruments that allow them to provide short exposure to financials. Typically firms issuing such swaps would hedge their exposure by shorting financial stocks.


When an ETF isn't creating new shares, it may trade at a premium to the value of its underlying holdings, since there is no new supply of shares to meet any increased demand. On Friday, for example, UltraShort Financials ProShares traded at a hefty premium to the value of its underlying holdings.


Amid the shifting short-selling rules, the ETFs will also likely have to pay more for the complex instruments that allow them to bet against financials, says John Gabriel, ETF analyst at Morningstar. Those higher trading costs could weigh down the returns of the funds.


"We expect pricing on these derivatives contracts will probably increase in the near future," says Steve Sachs, director of trading at Rydex. But "I wouldn't expect it to have a significant impact on the fund," he says.

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