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Traders Hedging with Short S&P 500 ETF


Put volumes swelled in iShares Russell 2000 (IWM) yesterday, with nearly 500,000 contracts changing hands. This has been fairly prevalent for the past several weeks as institutional portfolio managers are likely hedging small cap longs in portfolios on the way up.

In other cautious looking activity, ProShares UltraShort S&P 500 (SDS) calls were fairly active yesterday, and it is possible that these participants are aggressively hedging equity longs here, if not outright speculating on a reversal in the midst of earnings season. SDS has an expense ratio of 0.95% and IWM has an expense ratio of 0.28%.

SDS is designed to provide two times the daily inverse return of the S&P 500, but the word “daily” needs to be underscored and emphasized.

This is because the leverage within the fund resets daily, and as a result of daily compounding and potentially choppy markets, it is very possible to be directionally “right” in terms of when the position was established in such a fund, but “wrong” in terms of losing money on the ultimate trade due to the constraints here of daily leverage.

That said, on the flipside when the trend strongly agrees (and in short order) with the directional trade in the leveraged inverse product in this case, it is possible to realize short term returns in excess of the stated daily two times inverse target return.

In layman’s terms, un-leveraged inverse and leveraged inverse products are being utilized more and more by advisors and institutions alike for aggressive hedging/short term hedging purposes if not outright short term bull/bear directional trading, and it pays to understand “when” they are appropriate as part of an overall strategy or if they are simply not a fit given one’s goals, and these products are not designed to be “buy and hold.”

With broad market equities turning in an impressive month of January, where the SPX rallied more than 5% (barring today’s finish), it is not particularly surprising to see cautious flows in such products like SDS (note that call buying in this levered inverse product conveys bearish sentiment in the underlying “long” index), and we have documented put accumulation in IWM for the past several weeks during the markets’ climb.

The SPX has been unable to maintain its short term momentum above 1500 (traded as high as 1509.94 yesterday while trading below 1500 today) as well, and this has likely led to portfolio hedgers whom are long but looking to aggressively protect profits (note VIX slow climb back above $14 in recent sessions after trading as low as $12.29) as well as some looking to play a potential equity reversal in the short term in the midst of corporate earnings season.

So with “inverse” products on more radars now than ever, especially of institutional funds that are adeptly engaging in short term technical/trend based (or otherwise) trading to either hedge portfolios against short term swings if not outright speculate on direction, other products that may be exceptionally active in the short term include TZA (Direxion Small Cap Bear 3X, Expense Ratio 0.95%), SPXU (ProShares UltraPro Short S&P 500, Expense Ratio 0.95%), SPXS (Direxion Daily S&P 500 Bear 3X, Expense Ratio 0.95%), and SH (ProShares Short S&P 500, Expense Ratio 0.95%).

For more information on Street One ETF research and ETF trade execution/liquidity services, contact Paul Weisbruch at pweisbruch@streetonefinancial.com.