Anorak | How To Really Make Money on the Stock Market: The Misinformation Edge

How To Really Make Money on the Stock Market: The Misinformation Edge

by | 31st, October 2011

IT’S very difficult to make money on the stock market: most fund managers don’t even manage to bet the general rise (or fall) in the main markets themselves. And if those peeps making £hundreds of thousands a year can’t do it, why would we think that we would be able to do it?

The answer lies in the information edge. If you know something that the rest of the market doesn’t then you can make money: if you don’t have that extra knowledge then you can only make money through pure blind luck. And today I’m going to give you one of those pieces of extra knowledge:

If the Proshares are underperforming, there’s a simple arbitrage here. Take the ‘Ultras’, which offer 2x leverage, and the ‘UltraShorts’, which offer the opposite, -2x exposure. Going short both stocks generates a very low-risk portfolio pair, because on a daily basis when one goes up 1% the other will almost surely go down about 1% by design; the positions will offset each other. But the drift for both is negative, as they burn money. Since ProShares has been very busy adding ETFs, this simulated strategy started with 23 pairs in 2008, and is now up to 45. Below is a graph of the total return to going short all the Ultra and UltraShort pairs offered by Proshares since 2008. I rebalanced every week. The annual return was 14%, and the annualized standard deviation was 12%.

Now if you don’t understand that don’t worry: your stockbroker will and if she doesn’t then get another one who does.

Please note, I’ve no holdings or interests in any of this and I’m most certainly not being paid to advertise anything. What we’ve got here is an arbitrage opportunity. These don’t really exist in normal stocks and bonds any more, they were all found out decades ago. But ETFs are new, very new really, and so not all of the vagaries of how they behave have been worked out as yet. So, there’s an opportunity to make money out of having found a little wrinkle in the market.

Sadly, this little opportunity will only work as long as very few people are doing it. As soon as everyone piles in then the arbitrage opportunity will vanish.

Posted: 31st, October 2011 | In: Money Comment | Follow the Comments on our RSS feed: RSS 2.0 | TrackBack | Permalink