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Key risks to shorting high yield bonds like Sallie Mae or Sprint

Phalguni Soni

Will investors prefer investment grade over high yield in 2014? (Part 6 of 7)

(Continued from Part 5)

Shorting high yield bonds

High yield bond ETFs like the SPDR Barclays Capital Short Term High Yield Bond ETF (SJNK) and the SPDR Barclays Capital High Yield Bond ETF (JNK) have experienced record spikes in their short interest ratios (or SIR). The SIR for an ETF is the number of shares of the ETF that are sold short divided by the average daily trading volume, computed over the past 30 days. The ratio represents the average number of days required to enable short sellers to purchase the shares sold short or borrowed.

The SIR for JNK increased to 7.051x on February 28, 2014, the highest in the ETF’s history since its inception in November 2007, while the SIR for HYG increased to 7.746x on the same date, its third-highest level ever. The short interest, or the number of shares of a security or ETF that have been sold short by short sellers, increased to ~25.9 million on February 28, 2014, for JNK and ~30.2 million on February 14, 2014, for HYG—an all-time high. HYG tracks the iBoxx $ Liquid High Yield Index. The index is rules-based and provides a broad representation of the U.S. dollar–denominated liquid high-yield corporate bond market. With an expense ratio of 0.5%, the top ten holdings in HYG include Sprint 144A 7.875% (S), with 0.57% of total assets, and Sallie Mae 8.45% (SLM), with 0.39% of total assets.

What are the risks to short sellers in short sales?

Theoretically, the downside risk to the short seller of a security is unlimited. This is because, when it’s time to return the securities to the lender, the short seller must purchase it at whatever price prevails. Theoretically, the ETF price may reach infinity. However, practically speaking, the short seller won’t be able to estimate his likely loss at the time of shorting, in the event the price of the ETF keeps increasing instead of decreasing. The upside to the short seller, however, is limited to the difference between the price at which the short sale was made and zero, since the price of the security can’t fall below zero. To find out whether the short indicator ratio will prove a bullish or bearish indicator, read on to Part 7 of this series.

Continue to Part 7

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