A World Without Shorts

The SEC has now implemented its short-selling ban: it’s on 799 financial stocks, which, interestingly, do not include XLF, the biggest ETF for financial stocks. In theory, if you wanted to short a given stock in the XLF basket, you could short XLF and then just buy the individual components you weren’t interested in. But there are easier ways of shorting, like selling calls or buying puts.

With short-selling banned, there will probably be a substantial move into the options market by the erstwhile shorters. That might well drive down the price of call options, especially on financial stocks but also on broader indices. And I’m reminded of the advice that call options can be a smart investment anyway, especially for younger investors who can afford to lose their money. If that was something you were thinking about already, right now (or some point over the next few weeks) might be a great time to enter the position.

On the other hand, all options get significantly more expensive in times of high volatility, so maybe the effect of the short-selling ban will simply be to make call options slightly less expensive than they were, but far from cheap.

I do wonder though about the opportunities this financial crisis provides to investors who can stomach illiquidity and have a long time horizon. There are many such investors out there, both retail and financial, not to mention all those university endowments, sovereign wealth funds, and the like. Does anybody have an idea of where the long-term, locked-up money is going?

As for anybody thinking of trying the short-XLF play, I have some simple advice: don’t do it. It’s more stupid than clever, and if anybody catches you trying to make such an obvious end-run around the new regulation, you’ll deserve the large fines the SEC will surely find some way to impose on you. After all, anybody doing such a thing is a financial terrorist!

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