SH: A Simple, Effective Bet Against The S&P 500 (NYSEARCA:SH)

There are many reasons to short the S&P 500 (SPY), and multiple ways to do so, each with their own advantages and disadvantages. The ProShares Short S&P500 ETF (NYSEARCA:SH) is one of the easiest ways to best against stocks as it is unleveraged and has no expiry, unlike options. It also pays a “special” dividend, although whether this will add to profits or lessen losses will depend entirely on your timing.

A “Vanilla” Short

SH is an inverse ETF which seeks to return -1x the daily performance of the S&P 500. Its simplicity is its main appeal. There is no need for options, no borrow fee rate and the position can be held in a share-dealing brokerage account next to other shares and ETFs. Furthermore, there is no danger of large losses due to leverage; this is a plain inverse play on the S&P 500 which should deliver opposite returns. However, one issue strikes me straight away: it does not always achieve this.

Diverging Returns

Most investors will be familiar with the danger of leveraged inverse ETFs, which can significantly underperform their intended results over longer holding periods due to the effects of compounding. The danger in SH is less as it is unleveraged, but returns can still vary, both on a daily basis and cumulatively. The surprising thing is this seems to work in its favor.

The below graphic from the fund page shows the daily performance of the S&P 500 compared to SH:

The discrepancies are not that easy to see on the chart, so I will provide some examples:

January 31st: S&P 500 -1.61%, SH +1.63%

February 8th: S&P 500 +0.06%, SH -0.03%

February 22nd: S&P 500 +2.11%, SH -2.07%

For every date I checked, SH actually performs better than 1x inverse. When the S&P 500 drops, SH delivers a slightly better gain. When the S&P 500 rises, SH drops less. Even in a flat market with minimal movement, SH often delivers around 0.03% more than it should.

The worry is that a longer holding period could underperform. As the ProShares page warns:

For any holding period other than a day, your return may be higher or lower than the Daily Target. These differences may be significant. Smaller index gains/losses and higher index volatility contribute to returns worse than the Daily Target. Larger index gains/losses and lower index volatility contribute to returns better than the Daily Target.

This table from the prospectus outlines some hypothetical scenarios under various volatility rates. The darker shaded areas are where the returns are expected to be worse than a simple 1x inverse of the S&P 500 due to high volatility rates.

There is an upside to this, however.

Your return will tend to be better than the Daily Target when there are larger Index gains or losses and lower Index volatility.

This has been the case in recent history as volatility has been low. This is true when the S&P 500 is falling, like it did from late 2021 to October 2022:

And also when the S&P 500 is rising, as it has since October 2022.

S&P 500 volatility has been mostly in the 10-25% range since October 2022, and if we refer back to the table in the prospectus, a 40% increase in the S&P 500 would be expected to correspond to an approximate -29% loss in SH. This is very close to the price changes in the chart above.

The reason I have also included the total return in the second chart is to illustrate that SH has started paying a dividend, which boosts its return. This is a welcome, but probably a temporary benefit.

The Dividend

SH pays a 5.67% quarterly dividend (TTM) which beats most income stocks. However, SH can’t really be treated like other dividend payers. For a start, its distributions are erratic, as this 5-year graph shows.

Then there’s the obvious hurdle that the S&P 500 tends to go up rather than down, and any SH position should be temporary and certainly not held for a dividend. Nevertheless, it is a welcome by-product of the higher rate environment and SH’s holdings, which are part Treasury Bills and part swap contracts with various banks.

Other Considerations

SH has an expense ratio of 0.88% which is on the low side for this type of fund. Actually, it ranks third in all inverse ETFs, which can have expense ratios as high as 3.45%.

SH is a large fund with $1.06B AUM and excellent liquidity of $264.08M Average Daily Dollar Volume. I don’t see any red flags in other fund metrics and its only real competitor is the Direxion Daily S&P 500 Bear 1x Shares (SPDN), which is less attractive due to its small size at only $174M AUM.

Conclusions

SH is a simple, effective way to short the S&P 500 with an expected 1x inverse return. Concerns about varying returns look overblow, as this has recently worked in the fund’s favor. Furthermore, the 5.67% dividend boosts performance, at least for now, while T-Bill rates are high.