In a Woodbine Opinion publication entitled “The Value of Short Sale Restrictions” released on May 15, the firm asserted a favorable view on restrictions.
Specifically, we favor a combination of the proposed, market-wide, permanent “Modified Uptick Rule” and the security-specific “Circuit Breaker Halt Rule.” This combination would impose full-time price tests on all securities as well as halt short sales in specific securities for a period following a severe decline in price.
We view the proposed restrictions favorably to ensure the on-going underlying economic purpose of the equity markets: The transfer of capital from investors to companies and the transfer of ownership rights between investors.
When operating as intended, the markets drive economic growth by facilitating an important process by which companies can raise term funding for expansion-related projects. To do this effectively, markets must cater to investors who put forth capital and hold positions. If markets do not reflect the underlying fundamental value of their investment due to volatility or manipulation, investors will look to alternatives to invest their capital.
Making the markets more investor friendly will, no doubt, work to the detriment of high-frequency traders. These traders generate returns by trading in and out of stocks to capture small movements in price throughout the trading day. Short sale price tests may erode returns on these strategies by making short-selling more difficult by potentially preventing assumption of an instantaneously desirable short position.
Price-tests will likely complicate, but not eliminate, high-frequency trading. We believe that high-frequency strategies are developed by professional traders and quants and that those individuals are expert at adapting strategies to account for structural market changes.
Restrictions will not prevent but may impact the timing of some short sales. Price tests would not prevent investors with unfavorable views of a company’s outlook from assuming positions that profit from downward price movement. Unlike high-frequency traders, investors are generally less sensitive to precise trade timing because their return is generated through alpha.
Circuit breakers would often work to the benefit of investors as they would help curtail “panic” or electronically driven, event-based short selling. The halt would provide time for more complete information to be obtained and incorporated in pricing decisions.
The opinion piece can be viewed in its entirety on the firm’s website here.
About the Author Matt Samelson is a Principal at Woodbine Associates, LLC, specializing in equity market structure, trading venues, electronic trading, and transaction cost analysis. He has a wealth of experience in U.S. and international equity sales and trading, quantitative analysis, consulting, and research. He has in-depth knowledge of trade strategy formulation, algorithmic trading, market structure, transaction cost analysis, and trading technology.