There are many reasons that investors may want to short-sell — or bet against — European economies, including the so-called “Brexit” and the growing number of bad loans on the books of Italian banks. Unfortunately, opening a foreign brokerage account and short-selling European equities is a complex, costly, and time-consuming process. The good news is that short exposure can be gained through the use of exchange-traded funds (ETFs).
In this article, we will take a look at how investors can short-sell European equities through the use of ETFs, as well as some important risk factors to consider when doing so.
What Is Short-Selling?
Short-selling is essentially a way to bet on a stock price falling over time. In order to accomplish the feat, an investor borrows shares of a stock from a brokerage and immediately sells the shares for cash. If the stock falls in value, the investor repurchases the shares at a lower price and replaces what it borrowed from the brokerage. The difference between the sale price and the purchase price represents a profit generated from the decline in value over time.
For example, suppose that an investor wants to short-sell Apple Inc. (AAPL) shares. The investor may borrow 100 shares from a brokerage at $95.00 a piece on January 15 and immediately sell the shares for $9,500 in cash. If Apple stock falls to $90.00 by January 30, the investor may repurchase 100 shares for $9,000 in cash and return the shares to the brokerage. The investor in this case would make a profit of $500 from the 15-day transaction.
Short-selling can quickly put downward pressure on a stock price because shares are being borrowed and sold into the market. During the 2008 financial crisis, short-selling became a self-fulfilling prophecy as borrowed shares decreased stock prices and encouraged more short-selling. These dynamics prompted some governments and regulators — including those in Europe — to ban short-selling until market conditions normalized.
European Short ETFs
Most ETFs hold assets such as stocks, bonds, or commodities of a given index with a price that’s closely tied to the net value of those assets. In contrast, short ETFs seek to perform as the inverse of a specific index, which they accomplish through short-selling stocks, trading derivatives, or using futures contracts. These ETFs are typically valued as the inverse of an index rather than by their net asset value over time.
There are many short ETFs targeting European indexes and the euro currency, including:
- ProShares UltraShort FTSE Europe ETF (EPV )
- Market Vectors Double Short Euro ETN (DRR )
- ProShares UltraShort Euro ETF (EUO )
Investors should keep in mind that these ETFs carry a number of unique risk factors that don’t necessarily apply to traditional long funds. For example, short-selling is widely considered to be much riskier than purchasing assets because there’s unlimited downside. A long ETF may have downside that’s limited by the assets held by the companies in its portfolio, but short ETFs experience losses that are tied to theoretically unlimited upside potential.
Alternative Strategies
Investors interested in short-selling European economies with ETFs may also short-sell long ETFs. The process of short-selling these ETFs is the same as short-selling a domestic equity — the shares must be borrowed from a brokerage, sold for cash, and then replaced over a period of time.
There are many different long ETFs focused on Europe that investors can short-sell, including:
Short-selling long ETFs also has many risks that investors should carefully consider. For example, brokerages will often charge an interest rate for shares that are borrowed, which means that the profit from the position must exceed the position’s costs. These costs can be significant — in some cases up to 20% per annum — and may vary depending on the availability of shares to short at a given brokerage.
The Bottom Line
Short-selling European ETFs or purchasing short European ETFs are great ways to profit from the potential decline in European economies. However, short-selling involves a high level of risk that investors should carefully consider before investing.
