Financial ETFs Get the Short End of the Stick

July 31, 2007 at 8:30 am by Tom Lydon

The shorting of exchange traded funds (ETFs) in the financial-service sector is on the rise lately as hedge fund and money managers question the quality of credit, interest rates and stagnant corporate profits.

When shorting a stock or ETF, says John Spence for MarketWatch, the investor borrows the shares and sells them to other investors in the hopes the market will decline, and they can buy the shares back later. The investor gets the price difference once the shares are returned to the lender. Shorting stocks is a strategy used when trying to predict the market’s future direction or to hedge an existing position. High levels of stock shorting in a particular security or sector is typically seen as a bearish position.

Last week, banks, brokers and financial services stocks took the brunt of the burn, and investors wonder if the sub-prime mortgage crisis will spread into other parts of the credit markets. One ETF that has been shorted is the Financial Select Sector SPDR (XLF). Its short interest increased by 30% in June and in July. XLF is down 6.6% year-to-date.