October Rally Has ETF Shorts Scrambling To Cover

So much for October's reputation as a bad month for equities. After slumping more than 7 percent in the third quarter, the S&P 500 is up nearly 5 percent this month, and this October rally has short sellers scrambling to cover bearish bets on some well-known exchange-traded funds.

The October rally in equities has forced three consecutive weeks of covering in ETF short positions, reducing the shares out on borrow across scores of popular ETFs, according to research out today by S3 Partners Managing Director of Research Ihor Dusaniwsky. S3 Partners provides securities finance data and lending services to institutional investors, including hedge funds.

To this point in October, traders have covered $4.1 billion in short positions in the SPDR S&P 500 ETF SPY, the world's largest ETF. Keeping with the theme of short sellers scampering out of positions in large U.S. equity index products, shorts have also reduced bearish bets on the iShares Russell 2000 Index (ETF) IWM, the largest small-cap ETF, by over $500 million this month, according to S3 data.

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The Federal Reserve's Influence

Following the Federal Reserve's decision to not raise interest rates last months, traders have also been running to cover bearish wagers against an array of interest rate-sensitive ETFs, including some of the most heavily traded corporate bond funds.

The SPDR Barclays Capital High Yield Bnd ETF JNK, the second-largest junk bond ETF, has seen over $500 million in shares returned this month, while the Select Sector Financial Slct Str SPDR Fd XLF, SPDR KBW Regional Banking (ETF) KRE, iShares Barclays 7-10 Year Trasry Bnd Fd IEF and the iShares iBoxx $ High Yid Corp Bond (ETF) HYG have each seen between $200 million and $300 million in short positions covered in October, according to S3 data.

Traders' Movements Toward Fixed-Income ETFs

That jibes with data showing traders are rushing into fixed-income ETFs from the long side. To start the fourth quarter, five of the top 10 asset-gathering ETFs, including each of the top three, are fixed-income funds.

Some recently high-flying ETFs are seeing increased borrows by short sellers, though in the case of the Market Vectors Gold Miners ETF GDX, the largest gold miners ETF, how long shorts can ride this trade out is up for debate. GDX, the largest gold miners ETF, is up more than 22 percent over the past month, but shares out on loan in GDX have climbed $500 million in recent weeks, according to S3 data

Another playing with fire short trade has been shorting the iShares MSCI Brazil Index (ETF) EWZ. Until recently, shorting EWZ was almost free money, but the largest Brazil ETF has surged 12.3 percent over the past month as perhaps the one catalyst that could spark the downtrodden fund is gaining momentum: Impeaching Brazilian President Dilma Rousseff. Traders are betting the momentum will not last as shares on borrow in EWZ are up $200 million, according to S3.

Another ETF to watch is the Market Vectors Agribusiness (ETF) MOO, not because short interest is rising in the fund itself, but because bearish traders are feasting on some of MOO's largest holdings. S3 points Monsanto Company MON has seen $2.3 billion in new borrows in recent days ,accompanied by $500 million in new borrows for Potash Corporation of Saskatchewan (USA) POT. Those stocks combine for 12.2 percent of MOO's weight.