As you know, a few weeks ago the Securities Exchange Commission (SEC) temporarily banned the short selling of a large number of stocks.

Thie morning the SEC announced that it has extended its ban through October 17, 2008.

How does that affect our day trading? - Not at all.

Here's a short articles that Rockwell Trading's Head Coach Mark Hodge wrote on that subject last week:

As the markets digest the recent events on Wall Street, federal intervention and regulation have been used to stimulate an environment for growth and recovery. One of the most recent policies to be introduced is the SEC's Short Sale Order, but how does this affect you?

For the most part, the Short Sale Order will have little impact on day traders that trade derivatives (futures, options, etc). Remember that futures are used primarily to hedge positions. As hedges for businesses, or portfolios, the ability to take a short position is equally as important as being long. It is also important to know that futures on indices are cash settled. Taking a short position essentially creates a contract with another futures trader, based on the value of the underlying index. With futures on indices, there are no physical stock transactions that take place by entering long or short positions. Movements in the underlying index (example: S&P 500 index with stocks in the index currently on the short sale ban list) can be slightly skewed during the short sale ban, but trading short term moves shouldn't be a problem.

As a stock trader, the Short Sale Order banning short sales on the SEC's restricted list, will prevent you from taking short positions on specific stocks in or related to the financial community. This ban is temporary, and is set to be lifted on October 2nd (with the possibility for review and extension, determined by the SEC). For a list of the original stocks on this list, please visit the link below:

http://www.sec.gov/rules/other/2008/34-58592.pdf

The SEC ban is primarily due to unbridled short selling for profit, and the possible correlation to lack of investor confidence in the financial markets. The ban is also in response to accusations of naked short selling (no, not me trading from my bedroom), where institutional traders and hedge funds engaged in excessive short selling on distressed stocks. These accusations stem from selling opportunities and positions taken by hedge funds and institutional traders, where trades are initiated without locating the physical stock shares that are being sold. As a retail trader your broker needs to have shares on hand, or the ability to locate shares, in order to fulfill the short position you want to take. Lighter restrictions with institutions, and the possibility of naked shorts, led to greater pressure on stocks that were being targeted in the recent market decline.

Inverse ETFs, ProShares

If you are interested in downside market exposure, there are quite a few inverse ETFs that allow traders to benefit from declines in major indices. These inverse ETFs can also be used as portfolio protection. A few of the more popular are the UltraShort QQQ (QID), UltraShort S&P500 (SDS), and UltraShort Dow30 (DXD). ProShares offer 36 ETFs that track inverse moves in a variety of sectors, giving you downside exposure. ETFs are a great way to take advantage of selling opportunities that might be difficult to trade with the new SEC restrictions. UltraShorts give you double the exposure.

Two ETFs that have had some exposure to SEC restrictions are currently SKF (UltraShort Financials) and SEF (Short Financials). These 2 ETFs will not issue any additional shares, but will continue to be actively traded. This would mean that a potential increase in supply or demand in these ETFs could result in SKF and SEF trading at a premium or discount to the usual inverse of their benchmark index.

What makes inverse ETFs attractive, is the fact that downside exposure can be obtained without the use of margin. This means no margin calls or related concerns since an inverse ETF is traded just like a stock. In addition, risk is limited. Theoretically shorting a stock involves unlimited risk. Taking a short stock position exposes you to unlimited risk since theoretically the stock price has no ceiling. When trading an inverse ETF, the risk is capped by the price you paid.

Now you know...