3

If I have $200,000 in an index fund that mirrors the S&P 500, then I own the equivalent of 4+ thousand dollars in multiple high capitalization stocks. If I think that one of those stocks I already (kind of) own in the index is overvalued, I'd like to buy a short roughly equal to that stock's value in my fund. Let's say I think Facebook isn't worth its valuation, if I short $3,000 in Facebook shares (equal to my holding of Facebook in the index) and buy more of the index, it's like I own an index without Facebook. If Facebook goes up, my index goes up, but I lose all that gain when I close out the short. If Facebook goes down, I lose money in the index, but gain it all back in the short. The only way I lose money on the short is through the stock loan fee. But, from the perspective of the person loaning me the Facebook shares, this is the perfect loan; I'm never going to go bankrupt and leave them in the lurch.

Is there a financial instrument (maybe an index-backed short) that lets people short shares they already own as part of indexes for very low stock loan fees, since these loans are extremely low risk? If not, why is this a dumb or extremely niche idea?

Improve this question
1
  • Not sure about shares as never shorted 'em, but @ CFDs you pay or get also dividends when there are any, so you may get some profit in the fund (price or divi), but pay 'em while shorting FB thru ex-divi date.
    – Jan
    Jun 11, 2019 at 7:44

2 Answers 2

Reset to default
4

Per your link, you own 1.89% FB. Multiply that by $200k and you have $3,780 of FB risk. FB is approximately $175 so you'd short 22 shares for a credit of $3,850. The additional credit of $70 would coincidentally de-risk FB from the additional index purchase.

At my broker, the borrow rate for FB is currently 0.25% and the annual borrow fee for this short position would be under $10.

The only way I lose money is through the stock loan fee on the short.

Your short position in FB de-risks FB from the SPY's performance. You would lose money on the rest of the index if the market tanked.

Assuming that all components move equally, the end result is that you'd make about 98.1% of the index's up move and you'd lose about 98.1% of a drop.

Suppose you're correct and FB is overvalued and it drops twice what the market drops. If the market drops 10%, you'd lose $20.4k on the index position while making about $750 on the short FB position.

Is all of this worthwhile for such a limited hedge?

Improve this answer
2
  • 2
    Ah, so borrow rates are quite low for such large cap stocks and this is trivially easy without any special instrument.
    – lazarusL
    Jun 10, 2019 at 19:00
  • 1
    Borrow rates tend to be low for large cap stocks but they can vary, depending on the news. Not that it's a significant increase but when FB was getting pounded last summer, the borrow rate was triple what it is now. As an extreme example, the borrow rate for TLRY was 500% at the beginning of this year and it's now 22%. You don't want to be on the wrong side of something like that. Also bear in mi d that if the stock pays a dividend and you're short on the ex-div date, you pay the dividend to the lender.
    – Bob Baerker
    Jun 10, 2019 at 21:57
2

While possible in theory, there is no index-backed shorting available as far as I know, and there's several reasons why they probably won't ever be around. Mainly because it would cater to too small of a client base.

What you can do is regular index fund ownership plus regular shorting, which would fully hedge your Facebook position. Here's some considerations:

  • You'd have to tie up money equivalent to at least 1.5 times the amount you want to hedge (with a US brokerage at least). Once for the investment in the index, and the rest for collateral for your short position (50% of the amount being shorted). This amount would increase if the stock you're shorting goes up and your broker requires additional collateral.
  • This is essentially stock-picking, just done in reverse. Instead of trying to predict the winners, you're trying to predict the losers. It's a better approach (because predicting winners is statistically harder to do), but it's still trying to outsmart the market. The market is pretty smart, so don't take this lightly.
  • There's extra costs in commissions, share loaning fees, and, importantly, your time and ability to keep up to date with financial news.
  • Even if you're correct and the market is wrong, and by a margin wide enough to pay for costs and justify your time, the market can remain irrational longer than you can remain solvent. Imagine you did this in 1999, and correctly predicted that tech stocks were overvalued. You would have had to be willing to withstand a huge climb (and a lot of tied up collateral) before you got your (relatively small) payoff.

My advice is to let the market do its thing and price companies how it sees fit. The market valuations are usually closer to fair value than what any individual investor can come up with on a sustained basis.

Improve this answer
5
  • 2
    The OP is de-risking the FB component of his index holding by shorting FB shares. Whatever one position gains due FB rising, the other loses (or vice versa). There's no unlimited loss. It's a wash. Reg T margin (US) is 50% not 100% so he does not have to tie up money equivalent to twice the amount he wants to hedge. If both positions are held in the same account, he needs no cash to short FB shares since the index shares provide the margin. If separate accounts then 50% initial margin with 30% maintenance margin (credit balance divided by 1.3).
    – Bob Baerker
    Jun 10, 2019 at 23:29
  • You're right about the first point. I removed that section and clarified that there's no limit to the cash collateral that might be required. Your second point depends on your broker. The ones I know either require a cash collateral or charge you interest if you use your margin balance, but there might be some that use your other holdings as collateral with no extra charge.
    – Earth
    Jun 11, 2019 at 0:03
  • 3
    In the US, initial Reg T margin is 50% with a 30% maintenance requirement. Brokers can require more. Interest is charged for margin borrowing (buying). Shorting results in a credit to the account. You earn interest on that (and pay the borrow fee). The statement about "if FB triples on a $3000 short, you'd be asked for $6000 more in collateral to keep the position open" makes no sense. FB is $175 and is not going to triple or be supportable unless in the same account as the index shares. If not, the broker will cover automatically when the 30% maintenance level of ~ $202 is breached.
    – Bob Baerker
    Jun 11, 2019 at 0:44
  • @BobBaerker Thank you, it looks like I'm rusty on short sell requirements. I updated my answer.
    – Earth
    Jun 12, 2019 at 21:49
  • Good deal. It's a more cohesive answer now. Where I'd disagree with the new and improved version is 1) If index shares and shorting done in same account, you tie up margin, not money. If separate then yes, money tied up. 2) One has to be either oblivious or in denial when market drops over 50% in 15 months (see 2000 and 2008). Transitioning from long to short isn't rocket science and is very rewarding. Been there, done that in 2008 and 2009 and it was well worth the commission cost, borrow fees, and time. You wouldn't believe what I paid in borrow fees during those years if I told you :->)
    – Bob Baerker
    Jun 12, 2019 at 22:15

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .