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Do Reverse Stock Splits Affect Inverse ETF's?

Original post by Michael Wolfe of Demand Media

In lieu of buying a stock and holding it with the idea that the value of the stock will rise, allowing it to be sold later at a profit, a person can also "short" a stock. This means that the person is essentially placing a financial bet that the price of the stock will fall. This can be done by shorting the stock directly or by investing in a fund that shorts it, such as an inverse exchange-traded fund, or ETF.

Inverse ETFs

ETFs track certain financial holdings. Instead of being traded like a fund, it is portioned into stocks and sold on a stock exchange -- thus the term "exchanged traded fund." An inverse ETF is one that takes a short position on one or more assets, on the expectation that their value will decline. The price of the ETF moves inversely to the price of these assets.

Reverse Stock Splits

When a company experiences an inverse stock split, then the company sees a reduction in the number of shares that it has available, as multiple stocks are consolidated into a single stock. In a 3-to-1 split, for example, a stockholder receives one share of stock for each three that he owns. However, the price of each share of stock will triple, meaning the value of the stock will not change.

Changes

If a stock is listed in an inverse ETF, then movements in the value of this stock will inversely affect the price of the inverse ETF. However, during a reverse stock split, the value of the stock will not actually change. While the price will rise, the actual value of the stock won't, as the stockholder is left with proportionally less shares. Therefore, the price of the inverse ETF won't be altered.

Additional Effects

While a reverse stock split won't directly affect an inverse ETF, these splits may cause investors to feel differently about the stock. Sometimes, investors may welcome this split as a good business move. This can increase the demand for the stock, driving up its price and driving down the price of the ETF. However, if the market looks down on the reverse stock split, then the stock will decline in value and the ETF will rise.

                   

References

  • "Personal Finance for Dummies"; Eric Tyson; 2009

About the Author

Michael Wolfe has been writing and editing since 2005, with a background including both business and creative writing. He has worked as a reporter for a community newspaper in New York City and a federal policy newsletter in Washington, D.C. Wolfe holds a B.A. in art history and is a resident of Brooklyn, N.Y.

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