
ETFs: The next crash? - hardik
http://ftalphaville.ft.com/blog/2010/09/18/346406/can-an-etf-collapse/
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fraserharris
The second comment in the article is interesting. Basically, ETFs are open-
ended funds - you can't run out of the ETF securities because you can always
create more. So, if the naked short is called, and there are no ETF securities
on the open market to buy, the shorter can have an 'authorized participant'
create more ETF securities (see link). Note that this is a very different
situation than a stock, where there is a fixed amount of the securities
available, which can only be created by the company issuing more stock.

See: <http://en.wikipedia.org/wiki/Exchange-traded_fund>

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borism
yes, but the naked short must have the liquidity and solvency to purchase the
underlying securities needed to cover her naked short in ETF.

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cynicalkane
Same as any other stock. No reason ETFs are in any particular danger.

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joe_the_user
The difference between naked shorting and regular shorting is that with naked
shorting you only need the liquidity _later_. And they find out ... you don't
have the money!

All "financial innovations" boil down to ways of gambling with other people's
money. The brokerage that can do naked shorts in a conventional way are doing
it (see LTCM) and the article claims that EFTs open up this club to a wider
membership.

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cynicalkane
I have no idea what you're talking about, or why it's getting upvotes. Naked
shorts are "gambling", but it's with your own money, not other peoples. Also,
LCTM was not a brokerage. I have a feeling you're wrong about more things, but
I'm not confident I can parse your last sentence with 100% accuracy.

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borism
If you fail to understand the issue at hand why comment at all?

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mattmaroon
Clearly naked shorting needs to be either banned entirely or, perhaps,
regulated in such a way that the buyers realize what they're getting and who
the counterparty is.

The problem is that normal shorting is often maligned but a very valuable tool
for correcting markets and hedging positions. There's a strong outcry against
shorting from people who don't know better, and I think in response the very
valid complaints against naked shorting get drowned out.

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steveplace
"Abusive" naked shorting is already prohibited by the SEC, the enforcement,
however, is a little suspect.

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mattmaroon
How is abusive defined?

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steveplace
Structural risk in etfs will always be there as they are not pure holdings of
the underlying. For example, USO is a heavily followed (and traded) oil fund.
However, it deals mostly in near term derivatives contracts, and it will
continually underperform over time if the futures further out in time are
priced higher then the near term futures. Other etfs with this problem are UNG
and VXX and a host of others.

Structural risk in sector etfs are most likely not as high as what this
article states. Any market inefficiencies would most likely be fixed by
arbitrage, and arb firms may explain the large amount of shorts in XRT for
example.

One of the major risks I see down the road is if gold actually does become a
bubble. The major etf everyone watches is GLD, which does deal in physical
gold. If a bubble hits its peak and redemptions come in, they will have to
sell off some of that gold, which would accelerate the selling, providing a
positive feedback loop-- which is what we normally see when a bubble crashes.

Of course, all the risks I just mentioned, as well as the risks shown in the
article, are spelled out in each etf's prospectus, so this is nothing new.

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teyc
I don't get it. The volume of shorts in the markets is a dynamic quantity
right? In the absence of new transactions, these shorts would disappear when
the shares are physically transferred. Therefore, the risk here is
counterparty risk, but I don't see this risk as being peculiar to ETFs right?
Furthermore, once you have settled and obtained ownership, the risk is gone
right?

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bcl
This reinforces my belief that the 'market' is just one giant shell game.
Invest your money in something tangible like making a product.

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dschobel
What shell game? I can buy a share of Microsoft for ~$25 and then I get a vote
in how the company is run and receive a percentage of the profits. Microsoft
in turn gets to use the equity to build bigger and better things. Seems pretty
fair to me.

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mdda
It's not quite so simple. The $25 you spend on the share isn't used by
Microsoft : It's used to pay to the seller of the share.

Until Microsoft needs to issue more shares (or repurchase them), the value of
the stock is not meaningful (to the company). Of course, people with stock
options care about the value of the stock.

In the same way, it's actually bad outcome for a company to have their stock
jump up after the IPO : it means that the company missed the opportunity to
raise even more money (for the same amount of dilution for existing holders).

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known
I can say Gold ETFs aren't going to crash anytime soon.

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mindslight
Seriously? I've been figuring that fictitious gold is the next bubble to pop.
Physical gold is hard money; obligations to deliver gold are not.

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known
99% of gold supplies are controlled outside stock markets

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lzw
The blame may be pinned on ETFS if it happens, t the mechanism described in
this article is really a regulatory construct that creates a type of short
selling that is problematic. Maybe it might also exist in a free market, but
it is protected by regulation now.

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borism
yeah, I don't think the blame actually lies with ETFs. It's naked short
selling that is culprit again.

I would not theoreticize whether it should be allowed in free market, the fact
is it's illegal. However it might not be practical to demand all shorts to
deliver or cover now, but I think if they're not willing then each and every
one's financial positions should be assessed so that they have enough liquid
assets to do so later.

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BrentRitterbeck
Culprit of what? There's nothing wrong with the markets at the moment. They
don't go straight up.

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borism
culprit that is the topic of this discussion which is "ETFs: The next crash?"
as far as I can tell? Have you read the article?

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BrentRitterbeck
Yeah, I read the article. Naked short selling would have nothing to do with
this. The parent ruled out ETFs and substituted naked short selling for the
cause. You could view my post as highly sarcastic.

EDIT: Maybe I should clarify further. The next crash will not be because of
anything related to ETFs or any type of shorting. The next crash will be the
result retail investors having unrealistic expectations about how fast the
market will rise. The 1990s and mid 2000s set unrealistic expectations about
how fast the market will rise. When retail investors are not pulling off
double digit returns, they claim things are rigged and leave the market. This
is what will drop the markets again. I say we're looking at another major
downturn in about two years.

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borism
Naked short interest has nothing to do with naked short selling?

Would you then like to explain what has anything to do with this?

I find this issue highly important, so I wouldn't expect "highly sarcastic"
comments of very high use.

EDIT: the article is not about "The Next Crash". It's about the hidden risks
associated with ETFs.

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BrentRitterbeck
I read the parent's comment differently.

