Sizing an Inverse ETF Position as a Short-Side Proxy

Summary

The note considers how to represent the short leg of a pair trade when direct shorting is unavailable, using an inverse ETF as a proxy. Its suggested adjustment is to account for the inverse ETF’s beta when setting the hedge against the long position. This frames position sizing around the proxy instrument’s sensitivity rather than treating its share count as equivalent to the shares of the asset being shorted.

The response also says the pair’s correlation matters over the intended mean-reversion horizon, and cautions against correlation that is either too high or too low. It does not provide a sizing equation, explain how to estimate beta, or discuss tracking error, leverage resets, fees, or changing correlations. The advice is therefore a qualitative starting point, not a complete replication method or evidence that a particular inverse ETF will track a short position closely.

Key ideas

• An inverse ETF can serve as a proxy for a short leg when direct shorting is unavailable.
• Adjust the proxy position using the inverse ETF’s beta.
• Assess pair correlation over the intended mean-reversion horizon.
• The note gives qualitative guidance but no explicit sizing formula or tracking analysis.

Tags

# Replicating the short part of a long-short trade using inverse ETFs


# Replicating the short part of a long-short trade using inverse ETFs












I devised a pair trading strategy going long XXX and short B*YYY. B is the quantity of shares of YYY I need to short.

The problem is I can’t go short on YYY, but there is an inverse ETF for YYY called ZZZ.

Assuming that ZZZ is a good replicator of shorting YYY, how should I calculate the quantities I should buy for XXX and ZZZ to imitate the long/short trade?

## Answer by Tony (score 1)

https://quant.stackexchange.com/a/11414

Hedginge/Adjusting would be with the Beta of the inverse ETF. Usually, Long/Short strategy would involve an ETF and a stock in which you would Beta adjust the ETF position.

You can use an ETF, I don't see anything wrong with this as long as their is some level of correlation between the Short and the Long. You want them to mean revert in a determined time horizon so correlation is important. Not too high or too low.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.