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(NYSEARCA:SH) traded ex-distribution, which causes the stock to move down in value. The reasoning is: Value flows to the shareholder in the form of the distribution. This completely slipped our mind. We had only looked into Short S&P 500 ProShares (SH) as a pure play hedge. The distribution, which in the case of SH flows quarterly, caught us a bit off guard. With some ETFs it is annually.

The following points we ferreted out from our conversation with a Proshares Rep and have a bit of our overlay inter-twined. Normally, when shorting a stock, you can take the proceeds and invest in a money market. This money market produces interest, so you make a bit on the side while the stock tanks. Great! However, same concept, but different mechanics in SH.

SH is an investment primarily in swaps and futures, roughly 95% and 5%, respectively. What was conveyed to us was that the counter party delivers the dividend, which is invested in overnights on a daily basis. Of course, these are going to follow the current market rates. In this case SH it is yielding $0.52, which is subject to change in rates. If you bought at 60, the yield would equate to 3.4% annually with all things being held constant. This does not take into account the tax you pay, so be aware.

This raises a few more interesting issues. If we are in an efficient market, then the accumulation of interest and dividend should reflect in the value. When the funds distribute on the ex-day, you should be left with nothing but short exposure.

For theoretical purposes let's say the stock trades at $60 on ex-day. If you purchase the fund and hold, interest rates don’t change, the market doesn’t move, no taxes are taken out and they don’t charge any fees, you are left with this 3.4%. If that is the case, then you should have a 3.4% cushion or built in hedge on the hedge! In short, you have room for error on your allocation, as long as you hold through the dividends. Even better, SH distributes on a quarterly basis. It gives you a bit more maneuvering room. If our thinking is wrong or you have a different view, please contact us.

Thanks R.S. for the e-mail pointing out the distribution explanation. We seemed to have 'cried wolf' on the supply and demand issue on the 26th for SH. However, there are opportunities to gain or hurt yourself when selling on volatile days with ETF’s. This is follow up from previous post.

SH 1-yr. chart:

SH Investment

Source: More On S&P Short ETF