tag:blogger.com,1999:blog-14963913.post5732929564553168471..comments2023-10-27T20:27:57.900-04:00Comments on Kid Dynamite's World: An ETF Lesson - Part IKid Dynamitehttp://www.blogger.com/profile/17475987512856310577noreply@blogger.comBlogger53125tag:blogger.com,1999:blog-14963913.post-21604316076756551862021-02-17T01:23:39.221-05:002021-02-17T01:23:39.221-05:00Diamond hands GME GME GME Diamond hands GME GME GME Anonymoushttps://www.blogger.com/profile/11758974851735612827noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-77880623549218885492010-11-09T15:10:20.151-05:002010-11-09T15:10:20.151-05:00Anon - great question. let's talk about it:
u...Anon - great question. let's talk about it:<br /><br />using the SKF as an example: they are both inverse and leveraged (financial basket). They achieve their returns by using a series of daily rebalanced and daily rolled swaps and other derivatives. <br /><br />You (well, APs, of course) actually can create and redeem SKF - and when you do, Profunds (the ETF manager) will likely increase or reduce the quantity of swaps they have on their books. How do they do this? well, the counterparty for their swap has short positions in the underlying basket of stocks - so Profunds would pass this through to their swap counterparty when reducing/increasing the daily swap notional. (remember, Profunds is short the performance of a financial basket on swap - so their counterparty is long the performance of a financial basket (on swap to Profunds) and short a basket of financial stocks as a hedge.<br /><br />this is why the leveraged and inverse ETFs also frequently do a pretty darn good job of tracking what they are supposed to. APs just need to deliver the underlying basket - which the Trust will publish for them - they don't need to deliver "swaps" to the Trust. <br /><br />now, do they pose more risks? You may have already heard about the "gamma" effect of daily rebalancing - profunds mentions it in their prospectus:<br /><br />http://www.proshares.com/funds/prospectus.html?ticker=skf<br /><br />"At the close of the markets each trading day, the Fund will seek to<br />position its portfolio so that its exposure to its benchmark is consistent<br />with the Fund’s investment objective. The impact of the<br />Index’s movements during the day will affect whether the Fund’s<br />portfolio needs to be re-positioned. For example, if the Index has<br />risen on a given day, net assets of the Fund should fall, meaning<br />that the Fund’s exposure will need to be decreased. Conversely, if<br />the Index has fallen on a given day, net assets of the Fund should<br />rise,meaning the Fund’s exposure will need to be increased."<br /><br />this can lead to volatility around the close.<br /><br />the SKF also faced its own problems during the crisis when short selling of financial stocks was banned - they stopped creations and redemptions as a result of this. (or maybe just creations - I can't remember)Kid Dynamitehttps://www.blogger.com/profile/17475987512856310577noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-28647702176397225502010-11-09T14:42:40.781-05:002010-11-09T14:42:40.781-05:00I have a whole new question reguarding the creatio...I have a whole new question reguarding the creation/ redemption process. I understand how this works for a simple case of an ETF that consists of a basket of underlying stocks, but how do the APs arb the inverse ETFs, especially the multiple inverse ETFs which use derivatives to give inverse daily percentage closes. The creation or redemption process must be far more complicated than a simple index ETF. I am assuming the APs know far more about the composition of the inverse ETFs than I do, as reading the prospectus tells me nearly nothing about how the inverse ETF tracks inversly. In any case, assuming the APs do have more information, I feel that the markets for the derivatives that compose the inverse ETFs could possibly pose far more questions about the stability of these inverse ETFs, and about the ability of the APs to efficiently stabilize the ETF to its NAV. <br /><br />To summarize, my questions are 1.)Do inverse ETFs' creation and redemption process work the same as regular ETFs? 2.) If so, how do APs correctly arb the inverse ETFs with such a difficulty in assessing the underlying instruments they would have to be buying or selling to compose the ETF? 3.) Does the fact that the underlying basket is made up of dervatives pose more problems in times of panic?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-14963913.post-34980947076766926842010-09-23T18:01:41.996-04:002010-09-23T18:01:41.996-04:00Here Nemo, let me try to rewrite what I think your...Here Nemo, let me try to rewrite what I think your point is:<br /><br />If market participants are loose with their stock lending practices, there is a limit to the effect, since they can only lend their shares ONCE. But if the trust is too loose with its lending practices, the effect can be much greater, since the created ETF baskets will continually flow back into the trust so they can repeat their loan process.<br /><br />How's that sound?<br /><br />Of course, we already showed that this can all still be unwound (piecemeal) and also that it's not "naked shorting."Kid Dynamitehttps://www.blogger.com/profile/17475987512856310577noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-18237966061489299542010-09-23T17:51:00.800-04:002010-09-23T17:51:00.800-04:00Nemo,
I don't want to be rude, but you're...Nemo,<br /><br />I don't want to be rude, but you're just talking nonsense now. Terms have meanings - you can't just redefine them to fit your thesis. Impossible to borrow means no one lends. Not "no one lends except the trust."<br /><br />you are not ever going to encounter a situation where no one in the world will lend their shares, except some monkey at the Trust who keeps loaning them out mindlessly - but if you did, the stock wouldn't be impossible to borrow - it would be borrowable from the Trust (just as you DEFINED it to be!).<br /><br />and you keep mis-using the term "naked shorting." Naked shorting is shorting without a borrow. In every one of our examples, we have a borrow.Kid Dynamitehttps://www.blogger.com/profile/17475987512856310577noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-32134533041057716222010-09-23T17:13:02.068-04:002010-09-23T17:13:02.068-04:00KD --
Actually, I think we are getting close to u...KD --<br /><br />Actually, I think we are getting close to understanding each other...<br /><br /><i>If the trust is always willing to lend WMT, it's not impossible to borrow. By definition.</i><br /><br />Not at all! Just because one holder of WMT is willing to loan it out, that does not mean the stock is "easy to borrow", because that one holder can run out of shares to loan.<br /><br />For any stock, there are always some holders who are willing to loan their shares. But once everyone who is willing to loan shares runs out of shares to loan, the stock will become "impossible" to borrow.<br /><br />If the trust does not exist, then once that happens you cannot magically (and free of cost) create a new holder of physical shares who is willing to loan them out. But with the presence of the ETF, you can; you simply buy the shares, swap them for XRT, and sell the XRT. This costs you a net of zero (except transaction fees), and suddenly the stock becomes possible to borrow again because the trust will loan out the shares you just delivered.<br /><br />So I stand by my claim that the existence of these ETFs makes it possible to bypass naked shorting rules. In fact I am starting to suspect this is the primary reason they exist at all...Nemohttps://self-evident.org/noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-69667151416662871772010-09-22T18:22:48.244-04:002010-09-22T18:22:48.244-04:00Great to see some serious discussion here, thanks....Great to see some serious discussion here, thanks. <br /><br />As a clarification, the <i>nakedness</i> of the massive short interest in some ETFs is not material to our argument. These massive short positions in excess of the shares outstanding, are certainly serial short, if not technically naked (and are quite possibly some of both). We revised our <a href="http://boganassociates.com/whitepapers.html" rel="nofollow">article</a> slightly to clarify any confusion.Andrew Boganhttps://www.blogger.com/profile/02476018138604522417noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-37164267453546973882010-09-22T17:55:49.997-04:002010-09-22T17:55:49.997-04:00Outstanding commentaryOutstanding commentaryAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-14963913.post-8765331743114373512010-09-22T16:18:41.813-04:002010-09-22T16:18:41.813-04:00Nemo - I fear this is going to deteriorate quickly...Nemo - I fear this is going to deteriorate quickly. <br /><br />If the trust is always willing to lend WMT, it's not impossible to borrow. By definition. You're making your own rules, and then violating them a sentence later.<br /><br />again, note that your claim: "both involve getting short an instrument none of whose current holders is willing to lend it to you." is not debatable - it's false. The Trust is a holder, and in your own new rule, the Trust is willing to lend WMT. <br /><br />If we stick to the consistent, normal meaning of "impossible to borrow," then the trust does NOT loan WMT, and you can't magically get short it, as I illustrated already above. It's one or the other - either the Trust loans WMT, it's not impossible to borrow, and you can short it, or it's impossible to borrow, they don't loan it, and you can't short it.Kid Dynamitehttps://www.blogger.com/profile/17475987512856310577noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-71891978546076800732010-09-22T16:08:54.243-04:002010-09-22T16:08:54.243-04:00correction to earlier info: SPY does lend out thei...correction to earlier info: SPY does lend out their stock.Kid Dynamitehttps://www.blogger.com/profile/17475987512856310577noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-82890091894182952412010-09-22T15:13:07.875-04:002010-09-22T15:13:07.875-04:00I still disagree with your claims like "In my...<i>I still disagree with your claims like "In my example, they are getting short XRT without borrowing anything from the market." SS bought the stock from the market in step 1</i><br /><br />Right, they <b>bought</b> it, they did not <b>borrow</b> it. Enormous difference. Kind of my whole point, actually.<br /><br />Hypothesis is that WMT is impossible to borrow (in general). That does not mean it is impossible to buy and sell! So Desk 1 <b>buys</b> WMT from the market, swaps it for XRT with the trust, borrows WMT <b>from the trust</b> (which is always willing to lend), and sells it again.<br /><br />Or even move Desk 1 out of the company. Suppose nobody in the world wants to loan out their WMT. Fine, so you buy WMT, swap it for XRT with the trust, borrow WMT from the trust (who is always willing to loan), sell them again, and sell the XRT. You are now net short WMT free and clear, even though it was supposedly impossible to borrow!<br /><br />In essence, even if nobody in the world wants to loan out their WMT, anybody can create a willing WMT lender simply by purchasing shares and delivering them to the trust. And this can be repeated <i>ad infinitum</i>. (This is slightly different from my previous example. But both involve getting short an instrument none of whose current holders is willing to lend it to you.)<br /><br />This effectively bypasses any sort of restrictions on naked shorting... If you can merely <b>buy</b> the stock and <b>sell</b> the stock, you can automatically <b>short</b> the stock just by virtue of the ETF's existence. Assuming the ETF is a willing lender, that is.Nemohttps://self-evident.org/noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-65633025061126114862010-09-22T13:59:31.947-04:002010-09-22T13:59:31.947-04:00Nemo - I don't get your WMT example. If WMT is...Nemo - I don't get your WMT example. If WMT is impossible to borrow, how will SS (or anyone else) create XRT out of thin air? they have to deliver WMT to the Trust (even if it's borrowed WMT - which you've just declared impossible in your assumptions) each time they create XRT. <br /><br />If WMT can't be borrowed, XRT can't be created - except by people who already have WMT, of course, but in our example we assume that the T=0 state is:<br /><br />Market: long 1 WMT<br />SS desk 1: no positions<br />SS desk 2: no positions<br />SS trust: no positions.<br /><br /><br /><br />Desk1 buys WMT from the market, and delivers it to the trust to create XRT. Now positions are<br /><br />t = 1<br /><br />Market: flat<br />SS desk 1: long XRT<br />Trust: long WMT vs XRT obligations.<br />SS desk 2: flat<br /><br />you've declared WMT impossible to borrow, so the game is over. there's no more borrowing WMT to create XRT.Kid Dynamitehttps://www.blogger.com/profile/17475987512856310577noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-85778966539879027122010-09-22T13:30:21.566-04:002010-09-22T13:30:21.566-04:00Nemo - feel free to diagram your XRT-WMT example a...Nemo - feel free to diagram your XRT-WMT example as I did the other one above to try to illustrate your point - I will work on it on my end to see if i can get your point. (although I still doubt it, since I still disagree with your claims like "In my example, they are getting short XRT without borrowing anything from the market." SS bought the stock from the market in step 1 - and then repeatedly borrowed/lent it back to various internal SS desks. They did take delivery of stock from the market in step 1 - they had to, obviously.)<br /><br />to your other questions: yes - I would expect that a higher short interest relative to float would generally result in tougher borrow - because there's a higher probability that the borrowed and shorted shares will eventually end up with someone who won't lend them out. This doesn't mean that it's impossible to borrow, and it doesn't mean that shorts are naked shorts.<br /><br />and yes - of course XRT gets hard to borrow - I tried to short it several times between April and July and was not able to via Etrade. I don't know what it's like right now.<br /><br />as to the question about the fact of trusts loaning out their shares, this is what my people told me this morning:<br /><br />1) "I know that MER Holders cannot lend out the longs." - he's talking about SMH, BBH, etc. the Holders Trusts<br /><br />2) "i believe that UIT's are restricted but most ETF's are allowed under prospectus to loan out their holdings"<br /><br />3) the following trusts do not loan out their shares: SPY MDY QQQQ DIAKid Dynamitehttps://www.blogger.com/profile/17475987512856310577noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-85708514900890328492010-09-22T11:57:14.444-04:002010-09-22T11:57:14.444-04:00One last thought. If an instrument has 5x or 10x ...One last thought. If an instrument has 5x or 10x of its float sold short, wouldn't you expect that instrument to be hard to borrow?<br /><br />Are ETFs like XRT <i>ever</i> hard to borrow? If not, why not?Nemohttps://self-evident.org/noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-15318160078291626362010-09-22T11:53:29.778-04:002010-09-22T11:53:29.778-04:00bbg --
An ADR is exchangeable for a foreign share...bbg --<br /><br />An ADR is exchangeable for a foreign share (correct?), but those foreign shares are not sitting in an account where they can be loaned out. That is the critical difference.<br /><br />KD --<br /><br />No, the difference in your new example is that SS is actually borrowing the underlying from the market. In my example, they are getting short XRT <i>without borrowing anything from the market</i>. That is the definition of naked shorting.<br /><br />Let me try yet again. Simplify the picture by imagining that Wal-Mart were the only constituent of the XRT (hey, give it time). Suppose that WMT were impossible to borrow. Finally, suppose SS could simply create XRT out of thin air and sell it at will, recording nothing on their books other than an obligation to deliver WMT in exchange.<br /><br />The only reason this does not cause a "failure to deliver" is that whoever bought the XRT is not bothering (or is unable) to demand a redemption.<br /><br />And no, the naked short seller cannot simply borrow the shares and deliver them; if they could, they would have done that in the first place. The whole <b>reason</b> for naked shorting is that the underlying is difficult or impossible to borrow. In fact, that is another perfectly good definition of naked shorting: If you manage to get short an impossible-to-borrow stock, then you are naked shorting.Nemohttps://self-evident.org/noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-6225228470563107962010-09-22T09:27:59.115-04:002010-09-22T09:27:59.115-04:00Nemo -
i don't want to make this a semantic ...Nemo - <br /><br />i don't want to make this a semantic debate, but after going through the exercise and convincing myself that everything still works even in our unusual rules example, I am maintaining my insistence that you're using the wrong term in "naked shorting." I think that you seem to have some issue with the concept of "fractional reserve lending."<br /><br />I think you can prove it to yourself by doing the same exercise with no short sales - just borrow and create.<br /><br />Ie, Market starts out long underlying.<br /><br />SS Desk 1 borrows the market's stock (but doesn't sell it short!), and delivers it to the Trust to create XRT.<br /><br />T = 1 positions:<br /><br />Market: synthetic long underlying, with an IOU from Desk 1<br />Desk 1: IOU for underlying to Market, long XRT<br />Trust: long underlying vs XRT liabilities.<br /><br />now, Desk 1 can repeat a cycle of borrowing the Trust's long underlying, accruing IOUs (to deliver stock back) and creating XRT indefinitely.<br /><br />there are no short sales, and hence, certainly no naked shorts.<br /><br />When the entire scenario needs to be "fixed" - it can be - it just needs to be done one cycle at a time, just like it was created. Desk1 can redeem 1 XRT, <br /><br />ps - this claim of yours is false:<br />"When someone naked short-sells you a share of ordinary stock, it results in a "failure to deliver". If you go and pound on their door and say "give me my share, dammit", the only way they can comply is to purchase it on the open market (thus closing their short) and then deliver it to you."<br /><br />they can comply by simply borrowing the stock too (with consent, creating a consenting synthetic long), which is pretty much what SS did in our example.Kid Dynamitehttps://www.blogger.com/profile/17475987512856310577noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-52632142835263348862010-09-22T07:17:45.739-04:002010-09-22T07:17:45.739-04:00Nemo - If you substitute "ADR" for "...Nemo - If you substitute "ADR" for "ETF" does it make any difference to how you think about the issue? In both cases we're talking about a tradeable wrapper, and as far as I'm aware the structural issues are quite similar if not identical.bbgnoreply@blogger.comtag:blogger.com,1999:blog-14963913.post-49141518732152218772010-09-22T02:47:05.596-04:002010-09-22T02:47:05.596-04:00was that your point?
Essentially yes. My point is...<i>was that your point?</i><br /><br />Essentially yes. My point is only that this is a kind of naked shorting. Whether it is a problem depends on whether you believe naked shorting is a problem.<br /><br />When someone naked short-sells you a share of ordinary stock, it results in a "failure to deliver". If you go and pound on their door and say "give me my share, dammit", the only way they can comply is to purchase it on the open market (thus closing their short) and then deliver it to you.<br /><br />But this is exactly the situation SS is in in our hypothetical. Their net position in the underlying is zero, but their net short position in XRT is theoretically limitless. When someone demands to redeem some XRT, SS has no shares to deliver; they must purchase them on the open market, exactly like someone who naked-short-sold you ordinary shares. The only difference is that there is no visible failure to deliver up front. I don't think that changes the fundamental picture.<br /><br />Now, are failures to deliver -- or difficulties delivering -- necessarily so bad? I mean, it is not very different from having the shares delivered to you and then immediately loaning them out again to parties unknown... Either way, you wind up holding a promise for a share, not a physical share. It is just a number in a computer, and if you net all of the long+short positions in the world (including the naked shorts) you always get the correct number of shares outstanding.<br /><br />So I am not really trying to argue about what "the problem" is. I am only arguing that our hypothetical arrangement is functionally equivalent to naked shorting.<br /><br />Of course, this whole argument hinges on whether the trust can loan out its shares. There seems to be some disagreement about that... I would be curious to read an authoritative answer.Nemohttps://self-evident.org/noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-25136857941028775672010-09-21T23:47:05.619-04:002010-09-21T23:47:05.619-04:00Aren't these things just 40-Act funds? They c...Aren't these things just 40-Act funds? They can do securities lending.wcwhttps://www.blogger.com/profile/16307608293310560164noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-11827143722578598872010-09-21T22:24:58.492-04:002010-09-21T22:24:58.492-04:00actually, Nemo, maybe my last comment WAS your po...actually, Nemo, maybe my last comment WAS your point... it worked EVENTUALLY, but it had to be done piecemeal - the market couldn't redeem all of their XRT at once - only one at a time to unwind the circle and repeat the unwind process in reverse...<br /><br />was that your point?<br /><br />anyway, since the Trust cannot loan out shares, this is all a moot point, just a fun exercise, and not something to really worry about.Kid Dynamitehttps://www.blogger.com/profile/17475987512856310577noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-83543066335537120732010-09-21T22:17:39.614-04:002010-09-21T22:17:39.614-04:00Wait - Nemo - I may have had a Nemotic epiphany - ...Wait - Nemo - I may have had a Nemotic epiphany - shame on you for not forcing me to take these logical states to the next level earlier.<br /><br />after:<br /><br />T=4:<br />Desk 1 is flat<br />Trust is long synthetic underlying vs XRT liabilities<br />Desk 2 is short underlying<br />Market is net long 1 underlying and 1 XRT.<br />checksum: total is net long 1 XRT equivalent (just as we started)<br /><br />you're saying that we do it again... In a closed environment:<br />5) Desk 1 buys underlying in the market (but they don't buy a new underlying, they buy the one that the market is net long,<br /><br />T = 5:<br />Desk 1 is long 1 underlying<br />Trust is long synthetic underlying vs XRT liabilities<br />Desk 2 is short underlying<br />Market is net long 1 XRT.<br />total checksum exposure: net long 1 XRT equivalent<br /><br />6) Desk 1 creates XRT from their underlying, delivering underlying to the Trust,<br /><br />t = 6:<br /><br />Desk 1 is long 1 XRT<br />Trust is long 1 synthetic underlying and 1 real underlying vs 2 XRT liabilities<br />Desk 2 is short underlying<br />Market is net long 1 XRT.<br />checksum: long 1 XRT equiv<br /><br /><br />7) Desk 2 borrows the underlying stock from the Trust, shorts it in the market,<br /><br />T = 7<br /><br />Desk 1 is long 1 XRT<br />Trust is long 2 synthetic underlying vs 2 XRT liabilities<br />Desk 2 is short 2 underlying<br />Market is net long 1 XRT, 1 underlying<br />checksum: net long 1 XRT equiv<br /><br />8) Desk 1 sells their XRT to the market<br /><br />Desk 1 is flat<br />Trust is long 2 synthetic underlying vs 2 XRT liabilities<br />Desk 2 is short 2 underlying<br />Market is net long 2 XRT, 1 underlying<br />checksum: net long 1 XRT equiv<br /><br />now, the market wants to redeem their 2 XRT. so they tell the trust. the trust says "oh crap, we don't have 2 underlying, we only have 2 "synthetic" underlying, so they recall the borrow from Desk 2. Desk to goes out in the market and goes to buy 2 underlying - but there aren't two underlying... there's only 1 underlying - there only ever WAS one underlying... BINGO!<br /><br />so<br /><br />9) Desk 2 buys 1 underlying from the market and return their borrowed shares to the Trust:<br /><br />t = 9<br /><br />Desk 1 is flat<br />Trust is long 1 synthetic underlying and 1 real underlying vs 2 XRT liabilities<br />Desk 2 is short 1 underlying<br />Market is net long 2 XRT<br />checksum: net long 1 XRT equiv<br /><br />10) so the Market redeems one of their underlying with the trust:<br /><br />t = 10<br /><br />Desk 1 is flat<br />Trust is long 1 synthetic underlying vs 1 XRT liabilities<br />Desk 2 is short 1 underlying<br />Market is net long 1 XRT, and 1 underlying<br /><br />checksum: net long 1 XRT equiv<br /><br />BUT WAIT! now <br /><br />11) desk 2 can go out and cover their other short by buying the 1 underlying unit back from the market and returning the shorts they borrowed from the trust...<br /><br />t = 11<br /><br />Desk 1 is flat<br />Trust is long 1 real underlying vs 1 XRT liabilities<br />Desk 2 is flat<br />Market is net long 1 XRT<br />checksum: net long 1 XRT equivalent<br /><br />12) now the market can redeem their final XRT vs the trust!<br /><br />t = 12: <br />desk 1 is flat<br />trust is flat<br />desk 2 is flat<br />market is net long 1 underlying - right back where we started...<br /><br />so, my epiphany failed - sorry - I still don't get you. the process looks like it worked fine to me.<br /><br />:-(Kid Dynamitehttps://www.blogger.com/profile/17475987512856310577noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-57398353254019471482010-09-21T21:29:50.637-04:002010-09-21T21:29:50.637-04:00"And I do not see what difference it makes wh..."And I do not see what difference it makes whether a single company does this or several do so"<br /><br />So what? Dude, that's not what I'm talking about. "Do what" is the question. You have claimed that in your setup, there is not a borrow for every short. But you are wrong, as you could see if you took the trouble to work it through for yourself.Greycapnoreply@blogger.comtag:blogger.com,1999:blog-14963913.post-63193731356075344072010-09-21T20:14:23.412-04:002010-09-21T20:14:23.412-04:00Nemo:
this gets back to the question you already ...Nemo:<br /><br />this gets back to the question you already answered about what it means for the Trust to be "long" underlying - they don't really have long exposure from that - they have flat exposure, always - by definition. Maybe that's an important point: the trust is ALWAYS net flat exposure.<br /><br />SS's short exposure doesn't come from the Trust, it comes from Desk 2. That's an important distinction. It's definitely not in XRT, it's in XRT underlying - that matters too. <br /><br />The trust isn't really short XRT anymore than IBM is short its own stock when it issues stock in exchange for cash. It's just something for us to think about in terms of liability matching.<br /><br />In other words, the T=4 state is really:<br /><br />T=4:<br />Desk 1 is flat<br />Trust is long synthetic underlying vs XRT liabilities<br />Desk 2 is short underlying<br />Market is net long 1 underlying and 1 XRT.<br /><br />Now, you want to simplify (canceling out the underlying SS positions) that to:<br /><br />Desk 1: flat<br />Trust: XRT liabilities<br />Desk 2: flat:<br />Market: net long underlying, and net long XRT (which is what trust's liabilities are against)<br />SS net: XRT liabilities (which you are calling "short").<br /><br />this is kinda a bastardization, as the Trust's assets/liabilities don't work like that. But anyway, we can see, of course, that the net total position of everyone is still "long underlying" - after we cancel out the SS short XRT from the market's long XRT.<br /><br />SS has thus "borrowed" their short position from the market, in a convoluted way, by borrowing underlying stock before the creation.<br /><br />but maybe that's the whole point of confusion: we ARE actually creating shares here! That's the mechanism, as designed.<br /><br />perhaps you need to think of SS as two entities: 1) the Trust, which is always flat exposure, no matter what and 2) all the other desks combined - even pretending that they borrow from each other and the trust.Kid Dynamitehttps://www.blogger.com/profile/17475987512856310577noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-39038045575202554872010-09-21T19:11:56.496-04:002010-09-21T19:11:56.496-04:00KD --
Focusing on your T=4 state...
SS is net sh...KD --<br /><br />Focusing on your T=4 state...<br /><br /><i>SS is net short XRT underlying</i><br /><br />No. Desk 2 is short the underlying, but the trust is long the synthetic, so SS's net position in the underlying is zero.<br /><br />SS is only "net short" in the sense that they have an obligation to XRT holders. That is why I said they are "net short XRT".<br /><br /><i>so we can answer your question: "Now, where are the borrowed XRT shares corresponding to that short position?" (the net short held by SS)<br />Answer: they've been delivered to the "market"</i><br /><br />No. I am not talking about the (gross) short position held by Desk 2, which was properly borrowed from the trust.<br /><br />I am talking about the XRT liability which is, for all practical purposes, a short position in XRT. (SS's net worth goes up and down exactly as XRT goes down and up. That is a <i>de facto</i> net short position in XRT.) My question is, from whom was that XRT borrowed?<br /><br />In none of these examples am I talking about naked shorting of the underlying stocks. I am talking about naked shorting of XRT itself. In this example, SS's net exposure is short XRT, and there is nobody from whom that XRT was ever borrowed. (Indeed, they never borrowed anything from the rest of the market at all.)<br /><br />Put another way, the global net state at your T=4 is identical to T=0, except that the market is now net long XRT while SS is net short XRT. That's it. And that XRT was never borrowed from anybody. In principle SS could do this <i>ad infinitum</i>, because SS as a whole never has to borrow anything from anybody to execute this hypothetical transaction.<br /><br />Greycap --<br /><br />I am not talking about naked shorting of the underlying. And I do not see what difference it makes whether a single company does this or several do so in (deliberate or accidental) collusion.<br /><br />UrbanAnalyst --<br /><br />Thanks to for explaining some the differences between unit trusts and open-ended ETFs. I think it matters a great deal whether the fund can loan out its shares... Well, if you believe naked shorting is a problem, anyway.Nemohttps://self-evident.org/noreply@blogger.comtag:blogger.com,1999:blog-14963913.post-67724280524417702112010-09-21T18:49:09.991-04:002010-09-21T18:49:09.991-04:00Nemo, I don't think your analysis of this is q...Nemo, I don't think your analysis of this is quite right.<br /><br />1. Forced wind-down.<br />Now agree that this is an issue, I just don't think it is the same issue that you think it is. The problem is that if the ETF is just one leg of my position, I could go to bed thinking I'm flat and wake up with a big 1-way bet. But can we agree that this is not really a problem for the retail investors at whom the original scare story was aimed? The wind-down will happen when there is insufficient open interest in owning the ETF - not likely on a breakout to the upside. So it is unlikely to cost retail upside participation.<br /><br />2. Double shorting<br />Suppose that A has a long cash position in a stock. B wants to short it, so he borrows the shares from A and sells them to C. Now A decides he no longer likes the stock and sells it. But he doesn't have it any more! So his broker borrows it from C to deliver to D. You can see that this is just the ordinary chain of synthetic long/short positions described by Waldman and KD, except that the chain has been looped so that one link plays a double role. It is not true that a short sale occurred without a corresponding borrow. But A is in exactly the same position as State Street in your thought experiment, having "shorted the same shares twice."<br /><br />You stated that it didn't matter that a single agent was playing multiple roles, but I think that is the entire substance of your example.Greycapnoreply@blogger.com