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Tuesday, December 29, 2020

Inverse ETFs - A Brief Guide

تم إعداد هذا المنشور من قبل سنشري للاستشارات

Inverse ETFs - A Brief Guide
Inverse ETFs - A Brief Guide

*This performance is only observed with historical backtests and not traded by the company.

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The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.
Risks & Assumptions
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The below mentioned 2 Inverse ETF’s are designed & constructed to track the inverse of the normal SPX market returns.
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In case of bull markets, these ETF’s typically show decline in their value. As an example, both the ETF’s have shown Y-O-Y decline in their market values since their initial listing.
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Going ahead, should the current bull run in SPX index continue, these ETF’s may likely suffer from delisting risk. There is also a chance of getting no liquidity while exiting the ETF positions.
Summary

An Inverse ETF is an exchange traded product that is constructed by using various derivatives that aim to profit from decline in their underlying benchmarks that they track. They are also commonly known by other names including Bear ETF or Short ETF. They are typically used by investors to counterbalance any adverse drop in market prices. Although as per the definition, they are designed to provide inverse of normal market returns, these ETF’s may not provide exact matching of returns.

We take the case of 2 popular inverse ETF’s – ProShares UltraPro Short S&P 500 ($ SPXU | CMP: $6.16) & Ranger Equity Bear ETF ($ HDGE | CMP: $3.02). These instruments are currently available on IBKR platform. Both ETF’s primarily invest in instruments that seek to provide inverse daily returns of what normal SPX index provides. $SPXU for instance invests in different SPX 500 index swaps with major banks like Morgan Stanley, Credit Suisse, Citi & GS .It also holds some proportion in cash management & short term treasury bills. $HDGE holds short positions in US listed companies like FirstCash Inc, Vikar Corp, Akami Inc & WhirlPool. The fund selects these securities based on their low earnings quality as well as on downward earnings guidance. The entire portfolio of $HDGE consists of around 20 – 75 equity short positions with maximum short exposure per security not being more than 7% of the entire portfolio.

Performance of $ SPXU & $ HDGE during market downfall

For measuring the performance of both the ETF’s against SPX index, we make use of SPY ETF. SPY ETF is one of the oldest & well known ETF’s in passive investing space. This ETF tracks SPX 500 index, which consists of 500 major US large cap & mid cap stocks.

During the mentioned duration, their respective Low & High Values
Sr No Episode Duration $ SPY Peak Drawdown $ SPXU Peak Upside Movement $ HDGE Peak Upside Movement $ SPY $ SPXU $ HDGE
1 Eurozone Debt Crisis July,2011 - September,2011 -18.20% 39.25% 27.76% Low of 110.27 | High of 134.82 Low of 1140 | High of 1876.8 Low of 22.22 | High of 30.76
2 CNY Devaluation August,2015 - October,2015 -15% 25% 13.67% Low of 181.02 | High of 211.31 Low of 130.4 | High of 173.8 Low of 10.80 | High of 12.51
3 FED rate hike threat & Trump trade war rhetoric October,2018 - December,2018 -20.02% 45.75% 18.22% Low of 234.27 | High of 292.93 Low of 31.39 | High of 57.87 Low of 7.34 | High of 8.976
4 COVID 19 crisis February,2020 - March,2020 -35.44% 60.87% 36.54% Low of 218.26 | High of 338.12 Low of 17.09 | High of 43.68 Low of 5.045 | High of 7.95

$ SPXU & $ HDGE Returns (Data Source: Bloomberg)

As is evident from above, both these ETF's have performed strongly during periods of sharp market downfall. As an instance, during the recent market drop of February & March, 2020, $ SPY ETF dropped by around 35 %. $SPXU was up by 60.87 % & $HDGE was up by 36.54%.

Correlation with SPX index (Last 5 year Period)

As seen from below, both these ETF’s have show a high degree of negative correlation with SPX index. $SPXU for instance has a -98.9% correlation with SPX index. $HDGE has – 80.9% correlation with SPX index.

$ SPXU Correlation with SPX Index (Chart Source: Bloomberg)

$ HDGE Correlation with SPX Index (Chart Source: Bloomberg)

Risks & Assumptions

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The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
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Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
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Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
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The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
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Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
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Unforeseen events can lead to variation in performance from the tested trading strategy.
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The tested result has been computed with price feeds available from Bloomberg.
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The testing environment has not considered transaction or any other costs.
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Trading indicators used for the purpose of testing has been provided by Bloomberg.
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The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg

Arun Leslie John
Chief Market Analyst

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