Record low short interest in SPY, QQQ may expose US equities to vulnerability By Investing.com

The declining short interest in SPDR® S&P 500 (NYSE:) and Invesco QQQ Trust (NASDAQ:) exchange-traded funds (ETFs) to successive record lows has been supporting US equities and reducing volatility over the past year, thus serving as an implicit short volatility (vol) trade, JPMorgan strategists said in a Thursday note.

SPY and QQQ, major vehicles for placing index-level positions on US equities, have seen their declining short interest bolster US equity indices as investors gradually covered their short positions.

“In turn this steady flow support from the gradual covering of short positions has suppressed realized vol, creating additional space to take bigger equity positions in notional terms,” strategists noted.

“In other words, the declining short interest over the past year in these two major ETFs has become the equivalent of an implicit short vol trade,” they added.

However, with short interest at historically low levels, this extended implicit short vol trade poses a vulnerability to US equities if negative news reverses the decline in short interest, they added.

The declining short interest at the index level poses a question of whether this trend corresponds to rising short interest in individual stocks. However, data does not support this hypothesis, JPMorgan highlights.

The firm’s analysis indicates no significant increase in short interest over the past year for individual stocks, whether examining the largest tech companies or the broader universe.

“The declining short in SPY and QQQ ETFs does not only reflect a net increase in US equity exposure by hedge funds over the past year, but also a shrinkage of short sellers,” strategists continued.

They believe this shrinkage is driven by difficulties in maintaining short positions in a rising market, regulatory transparency increasing shorting costs, and active retail investor engagement deterring short sellers.