Diary of a Financier

Short SPY

In Trading Desk on Mon 18 Jul 2011 at 23:20
  • Shorted SPY @ $131.10 this morning.
  • Executed trade upon finding a big arb gap between ETF & its NAV.
  • Trade looks sound not only technically, but also as a hedge for long equity exposure.
  • Political resolution to US debt deal is a headwind.

I wanted to elaborate on the StockTwits trade rec I posted this morning:

$SPY shorted at 131.10. I need to hedge equity exposure, worry about slide below 130.5 in head n shouldrs. Daily n wkly show suppt at 126.18

So, I’m short the S&P 500 ETF (SPY) @ $131.10. There’s much to that trade, but I should start by mentioning that I found it a pricing anomaly at the time of execution, so I pounced on the entry opportunity. The S&P 500 (SPX ) itself was -0.63% when I placed my short order on SPY, which was persisting at a -0.43% level. At the same time, SPY.IV was -1%+ (that’s the ETF’s intraday NAV). Unless I made a clerical error, I thought, the ETF manager hadn’t been able to keep up with the sell orders, as it’s his job to redeem shares in keeping the SPY market price tied to NAV (and the SPX index it tracks on a percentage basis). This is the “tracking error,” by which the quality of all index ETFs is measured.

The big question, therefore, was which vehicle would move in which direction to close the arb gap. Since the technicals supported SPY falling intraday–and certainly did not support a rally in the indices–I initiated the trade. Here’s the 1-minute intraday chart I was watching at the time:

SPY intraday @ 948am

Notice the bearish indicators, which suggest the price will crash through nearby support around $130.86… and they did:

SPY intraday @ close

In longer fractals, it’s easy to see the mess of a week SPX has ahead of it. The daily chart shows a cautious combination. Having just broken down through its 50DMA, SPY is nearing trendline support that dates back to the bull market basin from March 10, 2009. SPY also closed tonight slightly below that historical prime meridian around $130.86, holding that crucial $130.50 support below which the Head & Shoulders neckline around $126 is the lowly support. Although, I’m likely to cover part of my short at $129.50 1st support:

SPY daily

I have reason to believe that the $129.50 1st support will hold up. The weekly fractal shows a dearth of buyer interest (MFI) on par with the market bottoms of 2002 & 2009. This comes in the midst of resilient momentum with SPY in the middle of its weekly trading range:

SPY weekly

I’m not quite sure how long I’ll be in this trade. While I have my targets as always, the market will ultimately tell me when to move. As I sit here tonight with a nice one-day profit in this position, I reflect on the conscious decision to open the short as a sound hedge for my long equity exposure. Given both the sound technical setup and the risk management premise, I have no trouble sleeping at night with an open short like this. As a standalone investment, short SPY in this environment would make my stomach turn–even considering the high-probability setup. The political risk is something with which I wouldn’t mess. (To clarify, Europe cannot be fixed. The political risk of which I speak comes from a US debt deal. I also recall a voice reciting ‘shorts have gotten burned at every turn in this market’ on CNBC this afternoon. You never know what the politicos can come up with overnight. Still, the Fed is sidelined for the time being, which is kind of like the Patriots without Tom Brady in 2008.) In light of the political will for asset inflation, I’ll be vigilant in preserving gains as always.


  1. Wow! Brilliant catch. I’ll be looking forward to your retrospective results.

  2. I’m going to cover the short (about -1.5%) early in this morning’s trading session. The political risk (US “Gang of 6” debt deal) swept in and stoked markets yesterday, turning my +1% unrealized gain into a loss in under 24 hours. Anyone who thinks this market isn’t volatile should reevaluate.
    I can try and excuse this loss as a hedge (EWJ +2.3% since short SPY initiated) which allowed me to crystallize relative value, but the fact is that I lost and I hate losing. In retrospect, SPY held the $130.50 support that I had noted as critical. I should have closed the position +1.3% before the 7/18 close, but daytrading is frowned upon–even though I was executing sound risk management principals.


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