PLEASE CLICK HERE TO SUBSCRIBE TO MY YOUTUBE CHANNEL @MoneyWithJames
#Money #Education #StockMarket #RealEstate #Learning #Finance #Investing #Learn #Wealth
In today’s post I will provide some insider reasons why some asset managers, banks and investors go short a stock. Expanding on the reasons I provided in my other post/video, click here for a link to that post/video where I give you answers to some stock market questions I was asked recently.
So, one of the reasons to bookmark my website, subscribe to my YouTube channel or follow me on Instagram or TikTok, aside from it hopefully being a little entertaining for a typically boring subject, is to hopefully get some insider insights into the topic of money. Today that topic is understanding short sellers or perceived short sellers. So as a former investment banker and now full-time investor, here are some of the lesser-known reasons for significant short positions in stocks.
First, pair trades, or otherwise known as relative value trades. What does this mean? Investors go long one stock, say Coca-Cola and short another stock, say Pepsi. These pair trades are more common for closely comparable companies so Coke vs. Pepsi or Nike vs. Adidas or sectors like Tech (growth) vs. Consumer Staples (defensive) and so on. So in isolation, it could appear the short interest is high in the shorted stock but maybe investors just think the relative valuation is off and they are partially-hedged and therefore this type of short holding is less likely to be an indicator for a short squeeze. It can also mean it’s less about being bearish on Pepsi and more being bullish on Coke but wanting to lower the risk and delta-hedge some or all of that view.
Which is the perfect segway into the second reason, delta-neutral trading. This is very similar to a pair trade in that offsetting positions must be held, but it is more because it lowers the risk of being wrong as related stocks often move together and therefore these trades try to just extract the alpha (the outperformance). Also, it can be a strict mandate for that particular fund of asset manager, as many hedge funds do not run outright long or short positions but instead they must always be delta-hedged. This means that if they wish to be long $100M of Coca-Cola stock, they must find a suitable offsetting $100M position, whether that is selling $100M Pepsi or perhaps $50M Pepsi and $50M of a basket of consumer goods stocks. In other words, you must never have an outright directional position, there must always be an offsetting position to the equivalent value. For example, when I worked for Macquarie Bank, a large Australian Investment Bank, almost all of their in-house equity trading needed to be delta-hedged, as they were more arbitrage focused trying to capture small gains often, which was drastically different to when I worked for Bank of America Merrill Lynch, a large US Investment Bank, where we could take large outright directional positions.
The third reason, is delta-hedging for derivative traders. And what does this mean, you might be saying? Well, there are things called derivatives, and just by definition that means they are byproducts and not actual things. Specifically in the world of money, that means, they are not assets themselves like real estate or stocks are, but instead they are financial contracts which are based on real assets. So knowing that, you can see if you create a financial contract based on an underlying asset then as the value of that underlying asset changes then obviously the value of that derivative will also change. That means the trader or investor that created the derivative will likely need to re-hedge that derivative – which means they will need to buy or sell some of that underlying asset to offset the change in value and risk they have. A little complicated the first time you hear this I now, but basically all you need to understand is there are trillions of dollars of derivatives in place at any one time, yes the market is beyond enormous, and that means that as real asset prices change so does the value of each derivative. Like I say, a little complicated but hopefully enough of an explanation for today.
Finally, the fourth and final lesser-known reason for material short positions today are ETFs, as I have discussed before, ETFs are exchange traded funds. They started out in the 90s as a rather simple product, providing investors with an ability to buy baskets of stocks – typically indexes (like the S&P500). So big banks and asset managers would buy all the individual stocks in an index in the correct ratios and bundle them up and allow other investors to easily buy one instrument (the ETF) and get the return of the entire basket. Yay! Great! Then over the years since then, ETFs have blown up into a multi-trillion dollar market and you can get an ETF for almost any basket you would like. For today’s post/video though, one of those things includes shorting stocks. Again, typically if you want to short a basket of stocks like the S&P500 you can do that using a derivative product or you can buy an ETF which provides an inverse return. So you buy ProShares Short S&P500 ETFs and you can get the same exposure as selling the S&P500.
So there we are, many reasons why some of the biggest investors are short and…not always because they simply expect the individual asset to go down. So be aware of these little nuances folks. Although this is not an exhaustive list and if you have any reasons you think worth sharing please drop them in the comments below!
Thanks for reading to the end! If you like this kind of information… then please consider bookmarking my website and subscribing to my YouTube channel as new posts and videos to come each week!
Leave a Reply