Can You Short an ETF?
Yes, ETFs can be shorted. Shorting an ETF works the same as shorting a stock. You borrow the ETF shares from a broker and then sell them in the open market. When you later buy back the shares to close out the short position, you will return them to the broker.
You can short most ETFs if you have a margin account and that particular ETF is shortable.
However, you must be aware of the disadvantages of shorting an ETF, such as margin fees and unlimited upside risk potential.
Shorting ETFs is riskier than buying an ETF because the ETF can increase indefinitely, while it can only go to 0 on the downside.
What is Shorting an ETF?
Shorting an ETF is when you borrow shares on margin to sell, then buy them back at ideally a lower price, so you generate a profit.
For example, if you short one share of an ETF at $100 per share and it decreases to $99, you can buy the share back and generate a profit of $1.
Shorting ETFs is not a traditional investment tactic; only advanced traders should attempt to time the markets.
Most investors would be much better suited to buying and holding ETFs over long periods of time to build wealth without having to worry about consistently timing the market.
Account Requirements to Short an ETF
A margin account is the most important thing you need to short an ETF. To open a margin account, you must have a minimum of $2,000 with most brokers.
Shorting stocks and ETFs is much different than buying an ETF because shares must be available to short. ETFs that are “hard to borrow” are not shortable since nobody is lending shares to short sellers.
Since you essentially borrow shares from somebody else when you short an ETF, you must provide collateral using margin. Margin enables you to trade with collateral and doesn’t require you to own any stock to use.
Reasons to Short an ETF
There are a few reasons investors and traders may want to short an ETF, such as hedging and speculation. If your portfolio has incurred significant gains, and you want to lock them in, you can short an ETF to reduce your risk if stocks decide to decrease.
Additionally, short-term traders base their trades on factors like technical analysis and order flow rather than the common long-term investing strategies. If a trader decides that an ETF is overbought, they can short the ETF to realize gains when it declines.
Hedge a position
Shorting an ETF provides your portfolio with downside protection. For example, if you believe that shares of stock will drop in the short term, you can short an ETF to hedge your downside risk.
Speculate on the share price declining
Traders can short ETFs to take advantage of market declines. Since active traders do not generally buy and hold stocks, they trade price action and can benefit when stocks move up or down.
How to Short an ETF
Short an ETF using margin
Using your margin account is the most common way to short an ETF. Given you don’t already own shares of the stock, you can sell shares short by placing a stand sell order.
You can’t short shares of an ETF you already own, as your broker will think you are simply trying to sell your owned shares if you try.
Buy an inverse ETF
A popular way to short an ETF without a margin account is to buy an inverse ETF. Inverse ETFs use futures and other derivatives to generate positive returns when the value of an ETF increases.
It is important to note that inverse ETFs use derivative products and will naturally decay over time. Therefore, inverse ETFs are not suitable for a permanent portfolio hedge since they only replicate the inverse returns of an ETF for one specific day.
Should You Short ETFs?
Most retail investors should avoid shorting ETFs because it requires time, knowledge, and skills, which most investors don’t have the time to learn.
The best way to invest in the stock market is to buy and hold shares of broad market ETFs.
Short selling is a short-term trade, and most investors do not accurately time the market.
Additionally, short-term trade comes with additional tax burdens since any profits you make will be taxed at a higher tax rate than the long-term capital gains rate.
Can You Short an ETF? | Bottom Line
Shorting ETFs is an advanced tactic that can help you hedge your portfolio or speculate on the stock market declining.
Shorting an ETF requires a margin account and is unavailable to cash and retirement accounts.
However, cash and IRA accounts can buy inverse ETFs to short the market without using margin and taking on unlimited upside risk.
Inverse ETFs utilize derivative products and suffer from natural decay due to how the funds are managed.
Therefore, investors should not hold inverse ETFs for extended periods of time to reduce the decay effects.
Shorting ETFs is an excellent way to hedge your portfolio, but investors must understand that hedging can also work against your portfolio.
If the stock market decides to move up after you short an ETF, you will incur losses, and it may be difficult to determine when to cut your losses.
The stock market tends to increase over time, making shorting ETFs a poor long-term strategy.
Also, sign up for my email list to be the first to know when I publish a new blog post!
Want to keep learning? Check out some of my other blog posts:
As Always: Buy things that pay you to own them.
-Josh
Blog Post: #078
