Challenges and opportunities of short selling in PH

After several years, the Philippine Stock Exchange (PSE) is finally scheduled to launch its short selling program on Oct. 23.

The PSE defines short selling as the sale of a security that will be settled by the delivery of borrowed securities.

It is hopeful that this new product will help boost market activity in the local bourse, which is clearly lagging those of other markets in the region.

At present, investors in the local market can only profit from rising prices as they can only buy stocks and other securities when they expect prices to go up.

With short selling, investors can also profit from an expected decline in prices as they can sell borrowed securities at a higher price and buy them back at a lower price in the future.

However, it might take a while for short selling to gain traction in the country.

Not all listed securities can be shorted. The PSE will initially only allow shorting of stocks that belong to the PSEi index, mid-cap index, dividend yield index and exchange traded funds.

The timing of the short selling service’s launch is also not good. Philippine stocks are currently trading at very cheap valuations with the PSEi index trading significantly below its historical average P/E multiple. Many stocks are also trading below their book values. Because of this, potential gains from shorting local stocks might not be lucrative to most investors.

It also costs more to short stocks than to go long. Investors who short stocks need to pay interest on the borrowed shares and reimburse the amount of dividends that accrue on the loaned shares on top of transaction costs.

Moreover, investors who plan to go short need to provide and maintain enough collateral before they can borrow shares. The required amount is quite significant at no less than 105 percent of the value of the borrowed securities.

Shorting stocks is also riskier compared to buying stocks. While the potential loss of investors who go long is limited to the amount of funds they used to buy stocks, the potential loss of investors who go short is unlimited because the price of stocks they sold can more than double.

Because of the higher costs and greater risks, short selling is not suitable for everyone. In fact, I won’t be surprised if stockbrokers strictly limit short selling services to more experienced and professional investors.

Over time though, it will be interesting to see the success and evolution of short selling in the country. Despite numerous growing pains, the development of new products such as short selling is necessary to keep the local capital market vibrant and to fuel its long-term growth. INQ