Paired ETFs Strategy Can Smooth Volatility

Given the recent stress test in the market, I thought it might be worthwhile to revisit an ETF strategy I explored last month: pairing a sector ETF with an inverse sector ETF so that the long holding went up a little more than the inverse ETF went down as the market moved higher over time.

The idea was to reap price appreciation of a few percent and some yield from both holdings. The goal was to try to capture most of the market's return with only a small fraction of the risk.

It seems to have delivered the desired results. Even better, it can work for several sectors, and may find more applications as ETF offerings expand.

In my initial column, I looked at the usually high-yielding financial sector. I paired the WisdomTree International Financial Sector FundDRF with the ProShares UltraShort Financials FundSKF, and looked at putting $20,000 into DRF and $10,000 into SKF.

If an investor had entered this pair on Feb. 26 (the day before the big dip started) at the open, he could have bought 698 shares of DRF at $28.62 and 145 shares of SKF at $68.58, making the invested amount $29,920.86. At the close on March 9, two weeks later, DRF closed at $27.43, down 4.1%; SKF closed the same session at $74.39, up 8.4%.

In dollars and sense, the combo was worth $29,932.69, up $11.32. During the same two-week stretch, the S&P 500 was down 3.3%. I'd say that judging by this small sample, the concept seems to work, and it sure was tested during that particular "dip."

Quite a Test The financial sector ETF pair trade survived the market's meltdown

Source: BigCharts.com

The concept stands up (so far, anyway) in other sectors, such as the utility sector. Take a look at the pairing of the WisdomTree International Utilities FundDBU and the ProShares UltraShort Utilities FundSDP during the same time frame and investment size:

Utilitarian Pairing This combination would've worked well, too

Source: BigCharts.com