June 24, 2020

Long High Beta, Short Low Beta

Long High Beta, Short Low Beta

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The long high beta, short low beta is a statistical arbitrage trading strategy that is a bet against beta.

To implement this type of strategy you must first find stocks with higher betas than the market and short them. The second side of this strategy is to buy long positions using leverage in stocks with lower betas than the market.

The theory of this strategy is that it creates an edge as the higher beta stocks are overpriced fundamentally and overbought technically at the time the lower beta stocks are underpriced fundamentally and overbought technically.

The expectation of the long high beta and short low beta play is that both sides of the trade will at some point revert to the mean. The high beta stocks will pull back to true value and the low beta will rally back to their intrinsic value.

The median is defined as the security market line (SML). The SML is a line drawn on a chart that is a visual measurement of the capital asset pricing model (CAPM). The CAPM represents different quantified systematic and market risk levels of markets currently compared to the future return expectations of the market.

The long high beta and short low beta play is a two sided hedge trade betting on a two sided reversion to the mean.  It has the safety of both a long and short side so has less risk exposure to directional market moves and is a trade on beta.