Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 105

Shorting and pairs trading using Exchange Traded Products

Imagine you have found a stock you think is likely to rise relative to the overall market, possibly because it is either technically oversold or fundamentally cheap. To trade this view, you could simply buy the stock outright, though that opens you up to the risk that its price could still decline during a market sell-off. To hedge against this risk, the alternative would be to enter a ‘pair trade’ whereby you buy the stock outright while also simultaneously taking a short position against the overall market. While usually the domain of sophisticated and institutional investors, exchange traded products allow individual investors to implement such trading techniques.

Stock versus market pair trade using the ‘Bear’ fund

Assume you expect the overall equity market to enter into a period of sluggish price growth or even price declines. In this environment, you might also expect relatively ‘defensive’ stocks such as Telstra to outperform. For example, in the two months from 13 October 2014 to 15 December 2014, the S&P/ASX200 traded largely sideways, rising by only 0.6%. During this same period, shares in Telstra rose by 9.5%. If you felt Telstra’s price was likely to continue to outperform, you could implement a pair trade by shorting the S&P/ASX200 and buying Telstra shares.

But how do you short the S&P/ASX 200 in a simple way? To obtain short exposure to the S&P/ASX 200, an investor could use the ASX-traded ‘BEAR’ fund, which is an Exchange Traded Product which sells the S&P/ASX 200 SPI futures contract (it invests nearly all its assets in cash and cash equivalents and obtains its ‘bearish’ exposure by selling SPI200 futures contracts). This means the price of the Bear fund is expected to move up when the S&P/ASX 200 falls and vice versa. Importantly, compared to short selling the physical shares or futures contract directly, the Bear fund does not impose margin call requirements on investors. All margin call requirements are met within the fund.

Figure 1: Returns of the BEAR fund after fees to 31 March 2015 (inception date 6 July 2012)

Bear Fund 2

Bear Fund 2

(Returns are calculated in Australian dollars after fund management costs, do not include brokerage or the bid ask spread, assume reinvestment of any distributions and do not take into account tax paid by investors. Returns for periods longer than one year are annualised).

The Bear fund should not be expected to provide the exact opposite of the market return over any time period. In the 12 months ending 31 March 2015, for example, the fund fell 10.3% even though the S&P/ASX 200 accumulation index rose by 14.1%. The reason is that, although the fund follows a rules-based strategy, these rules allow the fund’s market exposure to vary between 90% to 110% short on a given day. Therefore a 1% fall in the Australian share market can be expected to deliver a 0.9% to 1.1% increase in the value of the fund (before fees and expenses). The fund's approximate exposure to movements in the S&P/ASX 200 index, as measured by the futures contracts held in the fund, is quoted on the BetaShares website. For example, if the fund's portfolio exposure is -105%, and the S&P/ASX 200 index goes down 1% that day, the fund would be expected to go up approximately 1.05% that day, before fees and expenses. Note that the futures contract does not always align perfectly with the S&P/ASX200, and the fund is actively managed on a daily basis, affecting returns over time.

Sector versus stock pair trade using a sector ETF

For investors with access to stockbrokers providing short selling services, another pairs strategy could be used to take a view on a stock’s performance relative to that of its relevant sector. For example, if you believed BHP’s share price was likely to underperform the overall Australian resources sector, you could short BHP through your stock broker and buy a fund which provides broad sector exposure, for example, a resources sector ETF.

Another potential strategy for a portion of a portfolio is allocating 50% of investment capital to the Bear fund, and 50% of capital to a financials sector ETF. Investors could expect to generate ‘alpha’ provided the financials index outperformed the market – irrespective of whether the overall market rose of fell over the investment period. Replacing the financials ETF with the resources ETF, investors could expect to generate ‘alpha’ if the resource sector outperformed the market irrespective of overall market performance. In other words, if investors have a strong view that interest rates will continue to fall, they can take a view on the relative outperformance of the sector alone, using a combination of the Bear fund and the Financials Sector ETF. And if instead investors had a strong view that commodity prices would rise, they can take a view on the relative performance of that sector alone, using a combination of the Bear fund and the Resources Sector ETF.

While the premise of pairs trading is simple – simultaneously buy and short sell different shares or indices - there are more advanced pairs trading strategies which look at hedging or managing volatility. And, of course, investors in the Bear fund need to understand that, while it is expected to rise when markets go down, it is also expected to fall in value when market rise.

 

David Bassanese is Chief Economist at BetaShares, a leading provider of Exchange Traded Products on the ASX. This article is general information and does not address the personal needs of any individual. Pairs trading may be unfamiliar to many people and may not be suitable for everyone. Consult a licensed financial adviser before implementing any investment or trading strategy.

See this video interview with Alex Vynokur, Managing Director of BetaShares, for an explanation of pricing and liquidity for ETFs.

 

  •   16 April 2015
  •      
  •   

 

Leave a Comment:

RELATED ARTICLES

Profit from your principles

Australian ETFs: end of year reviews 2018

The challenges of building a lazy portfolio

banner

Most viewed in recent weeks

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

Warren Buffett's final lesson

I’ve long seen Buffett as a flawed genius: a great investor though a man with shortcomings. With his final letter to Berkshire shareholders, I reflect on how my views of Buffett have changed and the legacy he leaves.

LICs vs ETFs – which perform best?

With investor sentiment shifting and ETFs surging ahead, we pit Australia’s biggest LICs against their ETF rivals to see which delivers better returns over the short and long term. The results are revealing.

13 ways to save money on your tax - legally

Thoughtful tax planning is a cornerstone of successful investing. This highlights 13 legal ways that you can reduce tax, preserve capital, and enhance long-term wealth across super, property, and shares.

Why it’s time to ditch the retirement journey

Retirement isn’t a clean financial arc. Income shocks, health costs and family pressures hit at random, exposing the limits of age-based planning and the myth of a predictable “retirement journey".

The housing market is heading into choppy waters

With rates on hold and housing demand strong, lenders are pushing boundaries. As risky products return, borrowers should be cautious and not let clever marketing cloud their judgment.

Latest Updates

Interviews

AFIC on the speculative ASX boom, opportunities, and LIC discounts

In an interview with Firstlinks, CEO Mark Freeman discusses how speculative ASX stocks have crushed blue chips this year, companies he likes now, and why he’s confident AFIC’s NTA discount will close.

Investment strategies

Solving the Australian equities conundrum

The ASX's performance this year has again highlighted a persistent riddle facing investors – how to approach an index reliant on a few sectors and handful of stocks. Here are some ideas on how to build a durable portfolio.

Retirement

Regulators warn super funds to lift retirement focus

Despite three years under the retirement income covenant, regulators warn a growing gap between leading and lagging super funds, driven by poor member insights and patchy outcomes measurement.

Shares

Australian equities: a tale of two markets

The ASX seems a market split in two: between the haves and have nots; or those with growth and momentum and those without. In this environment, opportunity favours those willing to look beyond the obvious.

Investment strategies

Dotcom on steroids Part II

OpenAI’s business model isn't sustainable in the long run. If markets catch on, the company could face higher borrowing costs, or worse, and that would have major spillover effects.

Investment strategies

AI’s debt binge draws European telco parallels

‘Hyperscalers’ including Google, Meta and Microsoft are fuelling an unprecedented surge in equity and debt issuance to bankroll massive AI-driven capital expenditure. History shows this isn't without risk.

Investment strategies

Leveraged single stock ETFs don't work as advertised

Leveraged ETFs seek to deliver some multiple of an underlying index or reference asset’s return over a day. Yet, they aren’t even delivering the target return on an average day as they’re meant to do.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.