A lesson in Awfulness; Synthetic ETFs vs. Operational Shorting (and ETF Arbitrage) – No Safe Bets

*Sigh*

Another round of blowing smoke?

I am -guhhhhurghh- yet again, going to talk shit about the US Capital markets. . . Again.

Today’s menu includes a discussion on making Synthetic ETFs through contracts and another discussion on operational shorting. I will then perform the Chef’s kiss of adorning things with tidbits of knowledge and facts, to conclude with the combination platter on how fucked things are.

Simply because these things actually exist.

Let’s start with the Appetizer;

Synthetic ETFs (sometimes referred to as Swap ETFs)

Synthetic ETFs were introduced in 2001 in Europe and they’ve gained some popularity until IMF and a bunch of Financial Stability people complained about the imposed systemic risks on the market. Nowadays Synthetic ETFs are a sizeable chunk of the ETF-universe. –sauce

A synthetic ETF is a pooled investment that invests money in derivatives and swaps without the ownership of stocks or ETFs. Essentially think of an ETF that is a basket for synthetic derivatives and swaps instead of securities. So instead of stocks being in the ETF, you get Synthetic contracts.

The process of mirroring positions in a physical ETF with TRS’s and other swaps is called Synthetic Replication.

A Synthetic ETF uses things like Total Return Swaps for leverage. So it’s a bunch of swap contracts with a counterparty (like an investment bank). In theory, both participants of the contract must have sufficient collateral. But obviously, theory is for losers -so whether or not there is sufficient collateral is just a simple ‘trust me bro’ from going tits up.

Regular (also called physical) ETFs get leverage through shares, options, futures and other similar contracts. A physical ETF buys shares of an underlying index which is being tracked, synthetic ETFs do not.

Sometimes Synthetic ETFs follow some or all parts of an index, like a standard ETF. Sometimes the Synthetic ETF matches the portfolio of a mutual fund or some-other fund or even another ETF. Sometimes the Synthetic ETF is bespoke and made with all sorts of specific and peculiar entranched picks.

A Synthetic ETF can hold literally no stock. That’s a cool hat trick, or shell trick, depending on the aim of the game.

What’s crazy about Synthetic ETFs are,

That some ETFs are leveraged with Synthetic ETFs. Yes, so an ETF can have -you guessed it- another ETF inside. That ETF can also leverage contracts and swaps based on other ETFs. So it’s a big circle jerk.

Hell, it’s like a recursive strange loop Russian nest-egg doll thing. Essentially a big circle jerk.

What’s even crazier,

There are ETFs that are mixed, Mixed ETFs, they have both traditional stocks, bonds, options, and futures contracts AND also derivatives and swaps.

So these Mixed ETFs act like hedge funds that you could invest in and receive some form of dividend as they perform near-similar mechanics in the market as another hedge fund would through strategic use of all their options, contracts, etc.

So imagine a Mixed ETF that holds contracts and swaps on another Mixed ETF that holds contracts and swaps of it’s parent ETF. Yea, this shit is possible and it’s fucking bonkers.

We might as well make up a new form of currency backed by the trust and full faith of ETFs backed by none-other-than More ETFs. Might as well give the Federal reserve a run for it’s money. lmao, jokes.

Now on to the main course,


Operational Shorting

Operational shorting is short selling ETFs. Simply. But the operational part comes in by juggling ETF delivery and also short selling the underlying securities inside the ETF.

ETF FTDs (Failure to Deliver) have been growing since the adoption of SEC Rule 204T to reduce FTDs on traditional stocks. You can obviously tell that the FTDs transitioned from stocks to the ETF holding the stock.

So instead of directly shorting the stock, you could transfer your shorts into ETFs that hold that stock at some weighted percent. If you have FTDs on a stock, you could open a short position via the ETF, and then close your Short position on your stock, and you’d essentially be in the same boat. Many different ways to do this.

Essentially a shell game of hiding FTDs between the security and ETFs.

That’s basically the current meta. It’s to hide shorts from Stocks to ETFs, and then juggle them around in a shell game of hiding FTDs over and over. Lmayo.

This Operational shorting moving FTDs from underlying security to ETFs is done via,

ETF Arbitrage,

A small blurb for Authorized Participants (AP).

Imagine buying a pack of unopened Pokémon cards and then opening it, and then selling the cards individually -but without any physical or irreversible transactions. That’s ETF Arbitrage simplified.

ETF Arbitrage for Financial-Poke-mans hustlers

What one could do is that they can buy an ETF, and they’d be credited a weighted amount of the underlying securities. Then they could short one or all of those securities and use their ETF as a sort of collateral.

This is called ETF Arbitrage.

The short version is that the big boys (aka Authorized Participants) can assemble and disassemble the “basket of goods”. If they buy enough ETF shares, they can “redeem” them with the ETF Sponsor to receive cash and/or the underlying securities. Alternatively, they can buy up the various underlying securities, then send them to the ETF Sponsor to “create” new shares of the ETF.

–Saucey

Essentially buy the ETF, short sell the individual underlying securities.

What’s even better is,

You don’t actually have to buy the ETF.

You could short sell the ETF and because they have more lax FTD requirements (unique exemption of T+6). Now that you Short sell the ETF, you borrowed it -technically-, now you can short sell the underlying security.

Yes, it’s that retarded.

The SEC, in their infinite ignobleness, have authorized selling before locating of ETFs. It’s selling before buying, and not locating shares to borrow. That’s naked shorting, up to 50,000 shares at a time.

Yea, it’s even more retarded.

So APs and Market Makers might just naked short the ETF to indirectly short the underlying. Instead of directly naked shorting or regular shorting the underlying security, they curb their exposure by indirectly shorting or naked shorting via the ETF.

Here’s a picture of ETF XRT so that you can just laugh at the shares outstanding compared to shares in actual reported existence;

I guess limits are meant to be broken, Lmayo
(Shares Outstanding is the limit to how many shares there should be)

I mean, if you look at the SI on various ETFs, you’ll see 200% or 400% + Short Interest. It’s fucking bonkers. Definitive proof that APs and Market Makers are definitely using the T+6 Naked Shorting authorized by the SEC.

The Stock Market is in a real barney of ETF circle jerks.

A cool tidbit is,

‘They’ can borrow from pension funds. Maybe you have an FTD you want to deliver for, or perhaps you want to post a collateral for short selling an ETF? Look no further than a Pension Fund that invested some ETFs through your own brokerage, or a brokerage that is willing to lend you that ETF share -for profit of course.

Typically most pension funds and mutual funds are lazy and try to seek ‘passive’ returns by retardedly sticking the fund into both Active and Passive ETFs because of marketing and ‘every body is doing it’. The pension funds are then used as padding for aggressive investment undertakers through solicitation of Brokers.

So what happens is the state’s pension funds invest in ETFs, and then they get borrowed against for some money. All because some shmuck think ETFs are safe, or they’re in on it. I mean, it’s a scam.

So the APs and Co may borrow against State Pension funds to short or help further the agenda of operational shorting. Someone could borrows ETF shares from a pension, chop it up for the underlying securities’ shares, loans those shares out again, short against those loans, then borrows those same shares again. Rinse and repeat ad infinitum.

All to risk your teacher’s pension funds, your government workers, firefighters, and even policemen.

Isn’t that rad?

Here’s another great piece of info,

The ETFs that are supposed to hold the stock or underlying asset, might not even have it. Yea. ETFs can also undergo contracts and options and short sell their own underlying. So the custodian or some other manager could stake the underlying security as a collateral, meaning the ETF doesn’t have the underlying security to give away.

But that won’t stop an AP from buy said ETF (that doesn’t have the share), to open the ETF and loan out the share that isn’t technically there. Wow, look at all these different ways to counterfeit shares.

What’s even greater,

Is that the ETF share itself could be synthetic and counterfeit. Remember, the SEC totally allows the

‘Sell first and ask questions later’ policy.

So an AP can create a non-real Naked ETF to open to get a non-real share of some equity and short with it.

Yes. It’s that fucked.

This method would circumvent some issues that arise with directly naked shorting the equity. Because you wouldn’t owe the underlying security directly, no, instead you owe the ETF.


Syllogism is the ‘combination of logic’. I know, big words for you.

So let’s combine ‘Synthetic ETFs’ and ‘Operational shorting’.

“In Theory”,

You could short an ETF (a mixed ETF) that holds an ETF which holds a parent ETF and then use that ETF to create an infinite ETF glitch to short infinitely the ETF underlying.

You can also short the fuck out of any associated securities held by these chained/stacked ETFs. Yea, let that sink in.

Basically, Infinitely short ETF stacks to infinitely short the underlying with synthetics and fake shares.

This is basically an infinite short glitch. lmao. It’s turtles, all the way down.

All for shorting purposes, -operationally of course.
It’s ETF turtles all the way down
ad infinitum

The Big problem,

There’s multiple AP (Authorized Participants) or Market Makers or Parties that are doing this. So it’s a cluster fuck of operational shorting. Not only that,

FTDs on ETFs don’t matter,

So people will spit and print and sell ETFs as much as they want. Reach up and grab the unending supply of ETFs in the air. Who gives a fuck about actually adhering to T+6? Threshold security for an ETF? Ha, jokes.

ll of this because FTDs only really get counted or matter when there is a share recall or something sim-muh-lah.


The Call was coming from in the house. Oh wait,

As it turns out, No one share recalls ETFs.


So these infinite counterfeit machines could exist in perpetuity. Yea, even fake synthetic shares created from this scheme ARE IN FACT in existence to this very day. Mathematically, it’s undeniable.

Naked shorts, yeah.

Have faith in these markets.

Lmayo, I’m here to give nightmares. Have fun sleeping on that piece of knowledge. Yea, rest ya pretty head.


In Closing,

All of this only feeds into the idea that ETFs are a scam.

I didn’t even go over what would happen if an ETF were to be delisted. That’s a whole other can-of-worms. It’s like cellar boxing but ETF style. Hmm, maybe I might make that an article some day. lol.

Hey bud, be not worried.

ETFs are largely unregulated. 🙂 🙂 🙂 🙂 🙂 : ) : ) 😀 🙂 😐 : | (Dying inside progresses)

And the SEC bois approved single stock ETFs too (as of June 13th 2022).

So consider the implications of indirectly shorting a stock via their Single Stock ETF, to have a ~1:1 leverage in shorting it because you have a -single stock etf-. . . Yea. Let that operational level of shorting begin –I guess.

Our future is looking pretty dim, it’s grrrrrreat.

Oh, before I go, the SEC is a bunch of clowns. They’re either bribed or silly amounts of stupid. Probably both. That’s my opinion. Thank you for existing, and as always-

*Not Valid Financial, Legal, Life, or Any Advice


P.S.

Big shout out to this video for explaining a ton about Operational Shorting, it helped a lot;

He also talks about XRT at the 28 min mark, lmayo. That’s where I got that 2015 screengrab.

Also here is their paper for reads and stuff;

https://jacobslevycenter.wharton.upenn.edu/wp-content/uploads/2018/08/ETF-Short-Interest-and-Failures-to-Deliver.pdf

“ETFs constitute 10% of U.S. equity market capitalization but over 20% of short interest and 78% of failures-to-deliver.” -2018 draft

Author: Elsie Hughes