“Borrow to short” suddenly costs much more than it used to: S3 Partners

There has been a sudden jump in the demand to borrow ETFs for purposes of shorting. Investors may be looking to short ETFs for various reasons, but one major factor is the sudden spike in the cost of options. Options are widely used for hedging strategies but have become expensive because of the intense, coronavirus induced volatility in the market in March. As a result, borrowing costs of ETFs have, on average, shot up 40% according to a report by data provider S3 Partners. (FT)

Investors have also homed in on shorting ETFs because they offer a liquid and tradable vehicle to take on certain customized exposures that earlier found expression through derivatives. In a way, ETFs have now “become the market,” because they accounted for nearly 40% of the daily trading volume on some volatile days in March.

Options costs “explode”

“Many of these investors and portfolio managers turned to the ETF market to create hedges and alpha plays [profitable trades] in this volatile market,” said Ihor Dusaniwsky, managing director predictive analytics at S3.

The resulting jump in demand for shorting ETFs pushed up their borrowing costs.

“The average cost to borrow for the $147 billion of ETF shorts was 75 (basis points) on March 1st, and as of March 18th, it has risen 40% to 105 bps,” Dusaniwsky noted. “ETF short-sellers, who were paying $3.1 million per day in stock borrow expenses on March 1st are now paying $4.3 million a day.”

Borrowing costs for fixed income ETFs soar

The coronavirus sell-off has especially been hard on the fixed income markets with liquidity drying up and causing pricing anomalies in some ETFs.

For instance, the borrowing cost for the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG) soared to 3.90%.

Other ETFs that proved expensive for short-sellers were the Invesco Senior Loan ETF (NYSEARCA: BKLN), the SPDR Bloomberg Barclays High Yield Bond ETF (NYSEARCA: JNK), the iShares US Treasury Bond ETF (BATS: GOVT), and the JPMorgan Ultra-Short Income ETF (BATS: JPST).

The turmoil extended to cryptos with a similar bump up. The Grayscale bitcoin ETF (OTCQX: GBTC) saw its borrowing cost surge to 9.9%.

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