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Feb 7, 2017

S3 BLACKLIGHT: Portfolio Managers are Taking Off Index ETF Hedges

With the major U.S. indices trading at all time highs, the investment grade corporate bond index and gold trading at positive levels and the VIX trading at historical lows, traders have been closing down some of their ETF hedges over the past month. Short interest in the Spider S&P 500 ETF (SPY US), iShares Russell 2000 ETF (IWM US), Powershares QQQ Nasdaq 100 ETF (QQQ US), iShares iBoxx USD Investment Grade Corporate Bond ETF (LQD US) and Spider Gold Shares Fund (GLD US) have all decreased over the last month.

Since January 6th, short interest in these five ETF’s decreased by a total of $7.2 billion, or 11%. Mark to market revenues, net of financing, showed a loss of $646.6 million. On an average short interest balance of $60.7 billion this equates to a 1.07% loss in one month.

Such large movements on the short side of ETF trading generally equates to rebalancing of portfolio hedges as most portfolios are significantly net long. The dramatic decrease of short interest in these mainstay ETF hedges means that either risk portfolios are getting less net long or portfolio managers are looking to capture more market beta instead of hedging it away.

If the activity is from delta hedging portfolios which are either getting less long or more short, portfolio managers are looking for a market that will be plateauing or declining in the near future. If the ETF buy to covers were transacted in order to generate more market beta, portfolio managers are looking to participate more fully in a market that will be increasing in the near future.

If we look at long ETF flows as a proxy for whether investors are getting longer or shorter in the market, we are seeing net outflows in four out of five of these major index ETF’s this year.

It appears that the long and short index ETF activity is predicting a short term lull or decline in the markets. The data suggests that portfolio managers are taking off index ETF hedges on portfolios which are less long than they were earlier in the year.

For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC     Ihor.Dusaniwsky@S3Partners.net
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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