Why Can You Short-Sell An ETF But Not An Index Fund? (2024)

The ability to short-sell an index exchange-traded fund (ETF) illustrates a key difference between ETFs and mutual funds. Shares in an ETF are bought and sold on a public exchange, as the name implies. Shares in a mutual fund are bought or sold by the financial company that manages it.

For that reason, there's no way to short-sell a mutual fund.

The two types of investment share many characteristics. Both mutual funds and ETFs consist of a pool of money from many investors that is invested in a selection of stocks or other assets sold in the form of shares.

An index fund, whether it's a mutual fund or an ETF, invests in the stocks that are listed in a particular stock index, matching its weighting as closely as possible. It is a passive investment, meaning that its contents change only when the index is updated.

The investor's return should be virtually identical to the return of the index, minus the costs charged by the sponsoring company. ETFs are known for their low fees, but it should be noted that index mutual fund fees have been substantially lowered in order to compete.

Key Takeaways

  • Index mutual funds and index ETFs both are comprised of shares in the stocks that make up a particular index, whether it's the S&P 500 Index or a specialized index such as the Vanguard Energy ETF.
  • Like any mutual fund, an index mutual fund is bought and sold directly by the company that manages it. Shares are sold only after the market closes.
  • Like any ETF, an index ETF can be bought and sold on an exchange.

Understanding ETF Index Funds

When you invest in an index fund, you are buying shares in a portfolio composed of stocks that are listed in a specific index.

This is a passive investment. There is no team of financial professionals behind the scenes deciding when to buy and sell shares. The contents of the fund, and its return to investors, are identical to those of the index.

You can buy index funds for numerous different indices, including the , the Dow Jones Industrial Average, and the Russell 2000. Or you can buy index funds for specific industries or sectors, such as the energy industry, technology, or gold.

Index funds reduce the risk of losses by spreading the investor's money equally among many companies. Few investors could buy equal amounts of shares in all 500 of the biggest U.S. companies but an S&P 500 Index fund gives that investor precisely that level of diversification.

The Biggest ETFs

Two of the three biggest ETFs by assets under management are S&P 500 Index Funds. They are SPDR S&P 500 ETF Trust and iShares Core S&P 500 ETF In third place is the Vanguard Total Stock Market ETF.

Short-Selling an ETF

The fact that shares in ETFs are traded on a public exchange gives them many of the same attributes that stock shares have. That includes short-selling.

Traders engage in shorting when they borrow stock, usually from a broker in order to then sell it to another party. Short sellers are betting that the stock's price will go down so that they can pay less money to buy it back and then return it to the party that lent it.

In a successful short sale, the short sellerprofits from the difference between the price at which the security was sold and the lower price at which it was bought back.

An index mutual fund, or any mutual fund for that matter, cannot be short-sold because its shares don't trade on the open market. They are bought from the company that issued it, and must be sold back to that company.

Other Trading Strategies

Investors are able to short sell an ETF, buy it on margin, and trade it. In other words, ETFs are traded and exploited like any other stock on an exchange.

Index ETF prices fluctuate throughout the trading day as the index that it is based upon rises or falls in value.

However, an ETF's price also depends on the forces of supply and demand. For this reason, an ETF might not track the market in perfect unison. Mostcome very close.

What's the Difference Between an Index ETF and an Index Mutual Fund?

Both are pools of money that are invested in stocks or other assets that are listed on a specific index. The fund mimics the index, and its performance should be identical.

There are a few differences:

  • Index ETFs were known for having much lower expense charges and fees than mutual funds. This has changed, with many mutual fund fees being drastically reduced in order to compete with comparable ETFs. Before you invest in either, check the fund's "expense ratio."
  • ETFs are traded on the open market. Mutual funds are bought and sold directly through the company that manages them.
  • Some ETFs have tax advantages over some mutual funds because they trade less frequently, realizing capital gains less often. ETFs and mutual funds are treated identically by the IRS, so any taxable distributions from an index ETF and an index mutual fund should be virtually identical.

Are All ETFs Index ETFs?

No. Although the biggest and best-known ETFs track the major stock indexes, an enormous variety of ETFs is available, and some use benchmarks other than an index.

Broadly speaking, there are ETFs that invest in stocks, bonds, U.S. Treasury notes, commodities, and currencies. As of January 2024, there are ETFs that invest in cryptocurrencies.

There also are sector ETFs that invest in specific industries such as healthcare, energy, or real estate.

What Is a SPDR?

SPDR is an acronym for Standard & Poor's Depository Receipt. All of the ETFs with SPDR in their names are managed by State Street Global Advisors. The best-known is the SPDR S&P 500 ETF Trust (SPY). It was the first ETF, issued in 1993, and it remains the world's largest.

The Bottom Line

From the casual investor's viewpoint, there is little difference between an index ETF and a mutual fund ETF. The ETF might have lower fees, but that has changed, so check the expense ratio before you choose.

If you're an active investor, you're probably not investing in index ETFs. They are passively-managed investments.

Nevertheless, ETFs trade just like stocks and you can buy, sell, or even short them just like stock shares.

Why Can You Short-Sell An ETF But Not An Index Fund? (2024)


Why Can You Short-Sell An ETF But Not An Index Fund? ›

In a successful short sale, the short seller profits from the difference between the price at which the security was sold and the lower price at which it was bought back. An index mutual fund, or any mutual fund for that matter, cannot be short-sold because its shares don't trade on the open market.

Can you short sell an ETF? ›

The short answer is yes – it is possible to short sell an ETF just as it is possible to short sell a stock. Short selling is a trading strategy that involves borrowing shares of a stock or an ETF from your broker and then selling them with the hope of buying them back at a lower price in the future.

Can you short sell an index? ›

Most short-selling takes place on shares, but you can short-sell many other financial markets, including forex, commodities and indices.

Why choose an index fund over an ETF? ›

Passive retail investors often choose index funds for their simplicity and low cost. Typically, the choice between ETFs and index mutual funds comes down to management fees, shareholder transaction costs, taxation, and other qualitative differences.

Does Vanguard allow short selling? ›

Short sales are permitted in approved Vanguard Brokerage margin accounts during extended-hours trading sessions provided that the security is available to borrow.

Why can't index funds be traded? ›

An index mutual fund, or any mutual fund for that matter, cannot be short-sold because its shares don't trade on the open market. They are bought from the company that issued it, and must be sold back to that company.

Can I short sell QQQ? ›

Yes. The QQQ, like other ETFs, resembles shares of stock in many ways. If your broker can locate QQQ shares for you to borrow, you can sell them short. Whether shorting a long ETF or going long, an inverse ETF is better is often up to the trader.

Can you short sell the S&P 500? ›

Because futures include "equity" indexes like the S&P 500®, Dow Jones Industrial Average®, and Nasdaq-100®, you can also short indexes to hedge your equities positions, as long as the number of short futures contracts matches the size of the equities positions and the index accurately reflects the composition and ...

Can you short sell the VIX? ›

Before shorting the VIX, it is important to consider several key factors that can impact the success of the strategy. One important factor is market sentiment. Shorting the VIX is generally more successful in a bullish or stable market environment, as the VIX tends to decline during these periods.

Is short selling allowed in Nasdaq? ›

There are also rules that direct how short selling works. They limit short selling in a selloff and ban naked shorting.

What is better, S&P 500 index fund or ETF? ›

The Bottom Line. Both index mutual funds and ETFs can provide investors with broad, diversified exposure to the stock market, making them good long-term investments suitable for most investors. ETFs may be more accessible and easier to trade for retail investors because they trade like shares of stock on exchanges.

Is VOO an index fund or ETF? ›

VOO - Vanguard S&P 500 ETF.

Why is ETF cheaper than index? ›

Because ETFs are bought and sold on the open market, the sale of shares from one investor to another does not affect the fund. The sale of ETF shares does not require the fund to liquidate its holdings or generate tax implications from capital gains, keeping costs to investors lower.

Does Fidelity allow short selling? ›

To sell short, you must have a Margin Agreement on file with Fidelity. To establish a Margin Agreement on an account, select Update Accounts/Features under the Accounts & Trade tab, and click Margin and Options under Account Features.

Does Vanguard have a short ETF? ›

Vanguard Short Term Bond ETFs are funds that focus on the shorter maturity and duration scale of the domestic fixed-income market.

Does Charles Schwab allow short selling? ›

Schwab's margin account also enables you to sell short and potentially profit from downward price movements. Selling short involves additional market risk; be sure to familiarize yourself with short selling before using this strategy.

Can ETFs can be sold short or purchased on margin? ›

ETFs can also be purchased on margin by borrowing money from a broker. Every brokerage firm has tutorials on trade order types and requirements for borrowing on margin. Short selling is also available to ETF investors.

Can ETFs be sold quickly? ›

It is simply an order to buy or sell an ETF at the best available price in the market at that moment. Pro: You can buy or sell as quickly as possible, because market orders prioritize speed of execution. Con: You do not know exactly what price you will pay or receive for the ETF. The market can change very quickly.

Can you sell an ETF whenever you want? ›

Trading ETFs and stocks

There are no restrictions on how often you can buy and sell stocks, or ETFs. You can invest as little as $1 with fractional shares, there is no minimum investment and you can execute trades throughout the day, rather than waiting for the NAV to be calculated at the end of the trading day.

How quickly can you sell an ETF? ›

ETFs offer guaranteed liquidity – you don't have to wait for a buyer or a seller. This means your ETF should sell on the day you ask to sell it as long as the stock exchange is open and your instruction is received in time.

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