PROSHARES SHORT S&P500 (SH) TRADE THESIS

PROSHARES SHORT S&P500 ETF (SH)

Bulls make money, bears make money, pigs get...
The long term trend of the stock market is up. Short Selling individual stocks is a high risk strategy, but in a bear market it is possible to make money and maintain downside protection against Long Term holdings during periods of extreme volatility.

The PROSHARES Short S&P500 ETF is an exchange traded fund (basket of stocks) designed to inversely mirror the S&P500 by a factor of negative 1. For example if the S&P 500 drops by 3%, the SH will increase in value by 3%. There is a 0.89% expense ratio. The ETF trades in the stock market in the same manner as a stock, using traditional buy/sell orders.

It’s important to understand what ‘Short Selling’ is and the history of it’s effects on the stock market as they extend from the Great Depression.

What is ‘Short Selling’?

In it’s simplest description, Short Selling is a bet that a stocks’ price will go down and profiting from it by selling shares that a ‘Short Seller’ doesn’t actually own with the objective of buying them back at a lower price. This is how it works.

1. Short Seller ‘borrows’ shares from a broker (note: he will have to return the shares)
2. Short Seller immediately sells the borrowed shares.
3. Short Seller buys back the shares at a lower price
4. Short Seller returns the shares to the broker
5. Profit is the difference between the original price the Short Seller sold shares at and the price he repurchased them at.

Let’s take a look at an example.

A Short Seller ‘borrows’ 100 shares from a broker and immediately sells them for $100 ($10,000). When the shares have dropped to $90, the Short Seller buys 100 shares for $9000 and returns the shares to the broker with a total profit of $1000. The process of repurchasing the shares and returning them to the broker is referred to as ‘covering’.

Since the general trend for stock prices is up, this is a high risk strategy. If the share value increases to $120, then the Short Seller will be ‘forced’ to buy those shares for $12,000. The Short Seller loses $100 for each $1 increase in share price, in this example a $2000 loss.

When a a large group of ‘Short Sellers’ bet against a stock based on a catalyst, and that catalyst does not materialize or the share price increases, then Short Sellers are forced to ‘buy shares’ (covering) before the losses increase. This is called a ‘Short Squeeze’ and rapidly increases the share price.

When there is a widespread strategy to ‘Short’ an individual stock or the overall market, this is called a ‘Bear Raid’.

Short Selling can be applied to all financially traded instruments, stocks, currencies, commodities.

The Uptick Rule

The Uptick Rule 10a-1 was first instituted by the Securities and Exchange Commission (SEC) in 1938 after the depression in the financial markets and eliminated in 2007. The uptick rule acts to protect stocks and the overall market in periods of sharp decline. Short sellers are prevented from adding to a downward spiral by requiring that consecutive short selling orders of securities cannot be executed without the stock trading higher at least once between short selling orders.

“In 1963, the SEC established three objectives in order to assess whether the uptick rule continued to be effective. Those guidelines stated that the rule should accomplish the following:
1. Allow relatively unrestricted short sales in an advancing market
2. Prevent short selling at successively lower prices, thus eliminating short selling as a tool for driving the market down
3. Prevent short sellers from accelerating a declining market.” Investopedia

There are two sides to the Uptick Rule debate;

1. For - The rule impedes Bear Raids in individual struggling stocks but also hinders the effects of a bear market from spreading to otherwise healthy stocks or economic sectors.

2. Against - The rule impedes the natural market process. Markets naturally balance themselves when ‘Short Sellers’ are required to buy back shares to return them to the broker or to cover losses.

TRADE THESIS

NOTE: THIS IS A TRADE THESIS TO BE USED ONLY DURING PERIODS OF HIGH VOLATILITY AND LARGE MARKET MOVES. DO NOT ALLOW THIS TRADE VEHICLE TO BECOME AN INVESTMENT.

The Trade Thesis is founded on three pillars
1. Hedging or downside protection - during high risk periods, it’s important to have downside protection to balance Long Term positions in order to minimize losses.
2. Bear Market Profits -  in a downtrend, the SH offers the ability to profit as the market declines.
3. Ease of Trade - short selling in individual stocks is a high risk strategy with unlimited loss potential if a stock or the market moves up. The SH is a very easy financial trading instrument which can be moved in or out of quickly as market conditions change.

What does that mean at MONEYWISEHQ

The reality of the market is that Short Selling exists and there is no longer an Uptick Rule to protect investors.

Computer algorithm trading programs, which incorporate artificial intelligence to execute unimpeded trades in milliseconds, are being used by funds which can move billions of dollars to influence the stock market. This drives the market upwards, but also sets up the potential for an engineered Bear Raid which can be profited from through Short Selling.

At MONEYWISEHQ we always try to follow the Big Money. On the way up, we follow the bulls. When the bulls step aside and the bears step in to become the Big Money, the SH is the easiest instrument to use to follow the Big Money in an overall market Bear Raid.

There have been four Bear Raids in the past ten years; 2009, 2011/12, 2015/16 and 2018. Each Bear Raid has generally lasted 6-9 months and is characterized by large market swings and high volatility which provides ‘Trading’ opportunities within a range pattern or at extreme levels.

A successful trader has to be aggressive to make money, but if you’re not defensive you won’t keep your money. ‘Stop Loss’ or ‘Decision Point’ prices are important to minimize losses, but an effective Short Selling strategy can offset losses and provide gains when the Bears are the Big Money.