Are We Ready to Short S&P 500 after Fed’s Commencement of Tapering?

The Federal Reserve announced the inception of tapering of its asset purchases later in November. On a monthly basis, the reduction will account for $10 billion less in Treasurys and $5 billion less in mortgage-backed securities. So far there was little market reaction on the news. The Fed effectively spent months signaling that a tapering would come, a move that appeared to take the sting out of the announcement. Instead, the focus for investors is on a disconnect between the Fed and market participants on the outlook on interest rates.

However, as the Fed gradually withdraws from stabilization of the U.S. debt markets, these will be the commercial banks who will increasingly assume that role meaning loans and credits will be somewhat less accessible. Base case scenario unequivocally points to U.S. companies – especially, various startups and small businesses – facing less comfortable conditions. Hence, the previously extremely unpopular and continuously loss-making shorting ideas now may finally be on the table.

ProShares Trust – ProShares UltraPro Short S&P500 (SPXU) is an exchange traded fund launched and managed by one of the most popular and trusted ProShare Advisors. It invests through derivatives in stocks of companies operating across diversified sectors. The fund employs a short strategy and uses derivatives such as futures, swaps to create its portfolio. It seeks to track -3x the daily performance of the S&P 500 Index.

In other words, the SPXU provides an opportunity by making money through shorting of the market. Hence, it is primarily appealing to traders, but the bets should be well-timed and for this purpose, an understanding of the daily variation trends makes sense. This last one-year period has been a tough one, except for the last week of October 2020 when the ETF rose by nearly 15%.

Why do we pick specifically a highly leveraged fund? Indeed, the SPXU is a leveraged ETF, and is rebalanced on a daily basis, demanding additional efforts by its fund managers, which also explains its relatively high expense ratio of 0.91%, similarly to the ProShares UltraShort S&P 500 ETF (SDS), and in contrast with most categories of ETF which charge less than 0.27%.

Here, investors will note that SPXU, just like other leveraged funds, thrive on volatility. This gives a unique trading idea to measure its share in a diversified long-short private investment portfolio subject to continuous monitoring of volatility – the one which is particularly suitable for options traders.