Use Futures to Go Short

The entire clamor about naked short-selling last week might have been interesting had it not been so unnecessary. Single stock futures (SSFs) can and have been used to do the exact same trade since November 2002. Advocates on both sides of the debate are arguing about the best way to escape a room whose door is and has been open.

First, let's take a little detour. Certain topics, such as gasoline prices and short-selling of stocks, get people's blood boiling. I laid out some of my feelings on short-selling and the uptick rule in a March Columnist Conversation posting. Let's stipulate there are a number of short-sellers who engage in rumor-mongering and other tactics both reprehensible and illegal. Off with their heads! But let's stipulate as well that there is an entire industry, including investment banking, brokerages and ratings agencies, devoted to the opposite on the long side and they have the full and unbridled support of the government and your tax dollars.

If you do not agree, consider the Federal Reserve's three pre-opening rate cuts in August 2007 and both January and March 2008, their assumption of Bear Stearns' garbage mortgage collateral in March and last weekend's willingness to extend the full faith and credit of the U.S. Treasury to Fannie Mae (FNM - commentary - Cramer's Take) and Freddie Mac (FRE - commentary - Cramer's Take).

What effect does this have, you ask? To expand on another Columnist Conversation, on April 29, 2008, the cost of a credit default swap on 10-year Treasury notes was 9.7 basis points. It has more than doubled since that time to 20 basis points. Next, the yields on these Treasuries have risen steadily from the March lows while corporate credit spreads have increased as well; I noted in May the highly negative effects of higher realized borrowing costs on stock prices.

If anyone wishes to compare the total costs to you as a citizen and as an investor in the form of inflation, credit risk and misallocation of resources of the government's repeated interventions in financial markets to those of a few naked short-sellers of mismanaged investment banks and mortgage lenders, please let me know.

Using Single Stock Futures

If any of the below looks at all familiar, I wrote a series of columns on SSFs in 2001 to 2003 when I was involved with SSF development for NQLX (originally Nasdaq Liffe Markets); I now advise OneChicago on SSF issues and applications.

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At the time of publication, Simons had no positions in the stocks mentioned.

Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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