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CFDs
How does the ban on short selling affect CFD traders?
Toni Case - October 02, 2008
The short selling ban instigated by the Australian Securities and Exchange Commission (ASIC) in response to the turmoil on financial markets has created confusion amongst CFD traders, many of whom have used shorting as a tool to profit from falling prices.
CompareShares asked David Skilton, sales director at CFD provider IG Markets to clarify what the ban entailed for the everyday CFD trader.
CFD traders can still use shorting to hedge an existing share or CFD position. Say a CFD trader is long 1000 BHP (long), does it means that he/she can only short 1000 BHP?
Response: David Skilton, sales director at IG Markets
“It basically means that you can only go short if you are hedging exactly an existing share (or CFD position). If someone were to go short 2000 BHP in the example above [i.e. they are long 1000 BHP] they would end up with a net short position of minus 1000 BHP. This would mean the client has gained an economic short interest in the individual share.
“To hedge exactly they should have only sold 1000, not 2000.
“In this instance the client has gone from being 'long' 1000 BHP to 'short' 1000 BHP (by selling 2000). This is a no-no.
“In essence, if you have a physical stock position, or even a long CFD position, which you wish to exactly hedge, then you can now do so.
“Given that we have no way of confirming whether the client actually does have the corresponding share position, the onus is on the client to confirm this with our dealers. Hence, no online trading for short-sellers as our dealers need to confirm with the client that they are actually 'hedging'.
“In real terms - let's say you have 1000 BHP, which you hold in your share portfolio. If you are nervous about the short-term prospects for BHP, but you don't wish to sell the shares, you can now 'short' 1000 BHP CFDs - this is your hedge. If the stock falls you will make money on the CFD, but your shares will lose value and vice versa. However, if you shorted 2000 BHP then you would make more money if the share price fell than if it rose - you have created a short position and this is not allowed.”
How does a trader distinguish between hedging and shorting for profit?
“If the client's profit and loss ratio is flat (e.g. can't win/can't lose), regardless of what the market does then they are hedged.
“If they have shorted CFDs and there is no corresponding 'long' position then the trader is clearly 'shorting for profit'. Suffice to say, if the trader does not have any long CFD positions, or if they do not own the equivalent shares, then any short selling would be shorting for profit.
“It's the difference between short-selling to speculate and make money on a stock going down and short-selling to protect an existing holding.”
Will the ban on short-selling impact trading volumes (business) for CFD providers?
“Not as drastically as some commentators have suggested. We see less than half of our business on individual shares and roughly around 20-25% of that is short-selling. So about 8-10% of our business is short-selling on shares.
“Given that a fair chunk of this is people hedging their share portfolio (now allowed) then as you can see there is not a huge impact - particularly given the likely temporary nature of the ban.
“It’s clearly a big inconvenience for CFD providers though - and for their clients, particularly as the restrictions aren't anything as onerous as in other countries.
“It’s worth remembering that people can still short the ASX market as a whole though through a CFD, and volumes in this product have risen.”
How long will the ban last – do you think?
“It's fair to say that this blanket ban has not been popular at all and it goes far above and beyond similar (but less drastic) steps taken by other regulators.
“In the UK for example, short selling is banned, but only on financial and insurance stocks (until next reviewed in Jan 09). Longer term, similar less drastic steps would be more than adequate to protect the interests of the Australian market. The next review date is Oct 20th. We'd be hopeful that the current situation is improved then, if not before.”
Do you agree with the ban? If not, why not?
“We don't agree with the extent or the length of the ban. We understand the need to have significant measures in place for last Monday morning; the ASX was the first major market to open globally and could have been at the mercy of large-scale short selling if no action had been taken. But the 30-day time period seems unnecessarily long and the fact that all stocks were included in the ban is excessive. It's also inconsistent with other comparable exchanges.
“Also, the fact that this policy has had to be revised and amended so frequently over the course of last week suggests that it was not adequately thought through when first implemented.
“That said, we are more comfortable with the policy now that clients are able to hedge their portfolio - these people were unfairly penalised when the policy was first introduced last Monday.”
How will a ban on shorting affect the market generally?
“The ban on short-selling is not the panacea that some believe it will be. It's simplistic to think that recent volatility and market fluctuations can be attributed purely to short-selling.
“Any heavy overnight falls on Wall Street driven by bad news to come will still be reflected in our market - whether people are able to short-sell or not. After all, people can always still sell what they already have.
“The ban has resulted in a reduction of volume - last weeks volume was way down on the previous week. The market needed protection last Monday morning, which it duly received, many people are now questioning why the market must wait another 3 weeks before the policy is refined, made more relevant and brought more in line with other countries.”
Will the ban affect individual stocks? For instance, could it lend more support to some stocks?
“Clearly those stocks that have been targeted by short-sellers previously now have a degree of protection. Very few people however doubt that short-selling does have a legitimate place in the marketplace as a price discovery tool, so traders need to ask themselves whether this protection is justified, and what will happen when these measures, which are by their design temporary, are no longer in place.”
Do you have any further comments to make?
“The issues faced by CFD providers relate to their own hedging of their clients positions. Most (but not all) CFD providers want to have the positions they take from their clients to be hedged in the underlying market. If clients short-sell CFDs then providers such as ourselves can't pass that exposure on to our own brokers currently, which is why we can't let clients go short.
“The only other option is to allow clients to continue to go short, but not pass that exposure on and 'take it on the book'. Doing this would put us in direct conflict with our clients (we would need them to 'lose' in order for us to 'win') which is why IG would never take business on of this kind, irrespective of the fact that it does create inconvenience for some of our clients. It's fair to say that this isn't necessarily an industry-wide stance however.”
Whatever your views, you can discuss this article - or any of Toni's articles - on our message board Your 2 Cents.
Toni Case is the editor of CompareShares.com.au and is Australia’s first journalist to specialise on Contracts for Difference (CFDs). She was a staff writer for Shares, Personal Investor and Asset Magazines, and today is a regular columnist with the Australian Financial Review. She is a qualified financial adviser, and has an Economics (Honours) degree from Sydney University.
More articles from this edition of CompareShares:
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Resident Trader: Essential steps to successful intraday trading
CFDs: How does the ban on short selling affect CFD traders?
Ask the Expert – Forex: 5 essential things you need to know to boost profits trading forex
Fundamentals: How to value a stock – focus on QBE Insurance Group
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Stock markets: Global stocks sputter in anxious trading
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