“When you have eliminated the impossible, whatever remains, however improbable, must be the truth”.

Sherlock Holmes

Picking up where we left off in the Feed post, “Introducing Alphacution’s Strategy Factor Library,” with the chart below that combines stock and ETF positions:

It turns out that when we isolate the “shorts universe” factor for stocks from that of ETFs the picture changes only very slightly, as shown below:

Here, the most notable change is Susquehanna Securities moving in the ranking to a point where it may have a few dozen short stock positions. An alternative view, below, shows how each market maker was relatively consistent in their positioning during 20 quarters beginning Q1 2019 and ending Q4 2023. This begs the question of how often key components of core strategies change…

This same perspective for an isolated version of the “ETF shorts universe” is presented below. Here, we get an early indication that the capacity of the ETF shorts universe is much smaller than that of the “stock shorts universe.”

Finally – and arguably the most fascinating version of our shorts universe factor group – Alphacution presents a ranking of the estimated average ETF shorts universe by option market maker, below:

There’s a lot going on in this chart…

For starters, it seems rare to be short an ETF. That said, it makes sense that Jane Street Group (JSG) might be short many ETFs since a key component of it’s core trading strategy is to serve as a market maker and authorized participant (AP) – a financial entity that dynamically manages the creation and redemption of shares – for ETFs. Jane Street is also architecturally unique because it bifurcates most of its cash and option trading between Jane Street Capital (JSC) and Jane Street Options (JSO), respectively…

That said, the fact that both Cutler Group and HAP Trading – two of the smallest US equity option market makers – potentially have dozens of short cash positions in ETFs not only says something vivid about their core trading strategies, it also potentially says something dramatic about the methods by which small option market makers have figured out how to survive in an environment dominated by a very short list of wholesale option market makers…

Speaking of wholesale option market makers, one more fascinating observation from the chart above is that wholesale market makers who also actively trade in cash markets – like Citadel Securities, Susquehanna Securities (via numerous affiliates such as G1 Execution Services – not shown), and Two Sigma Securities – may be structurally limited to be short underlying securities. This possibility may further explain the reasoning behind Jane Street’s bifurcation of JSC and JSO. Strangely, it may also explain – at least, in part – Citadel Securities’ and SIG’s activity in equity index options…

See the Feed post, “Citadel Securities, SIG: An Analysis of Single-Security vs Index Option Allocations,” for more on that thread…

As always, there’s much more that could be said, particularly if we kept pulling from our chart library…

Let’s digest these thoughts until next time…