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Long/Short Hedge Strategy (US Market)

A protective approach for investors who are concerned about broad market declines but do not want to sell their value stocks. By going long cheap value stocks and shorting SPY (the S&P 500 ETF), this strategy hedges against systematic market risk.

Strategy Logic

  1. Long Positions (70%): Buy stocks in the lowest 20% by price-to-book ratio. These are the cheapest value stocks in the market. Use quantile_row to compute the cross-sectional percentile each day, then equal-weight the qualifying stocks and scale to 70% total long exposure.
  2. Short Position (30%): Short SPY as a market hedge, with a fixed allocation of -30%.

The combined net exposure is 40% (70% - 30%), substantially reducing market risk compared to a long-only strategy.

Code

from finlab import data
from finlab import backtest
from finlab.market import USMarket

data.set_market('us')

close = data.get('price:adj_close')
close = close[close.index.dayofweek < 5]  # remove weekends

pb = data.get('us_key_metrics:pbRatio')

# Lowest 20% by price-to-book ratio
position = pb < pb.quantile_row(0.2)
position /= position.sum(axis=1)

# Long positions total 70%
position *= 0.7

# Short SPY for 30% hedge
position['SPY'] = -0.3

report = backtest.sim(position, resample='Q', market=USMarket(), fee_ratio=0.001, tax_ratio=0)
report.display()

Key Parameters

  • pb < pb.quantile_row(0.2): Selects stocks whose price-to-book ratio is in the bottom 20th percentile across all stocks on each date. This is the classic "deep value" screen.
  • position /= position.sum(axis=1): Normalizes long positions to equal weight. Each qualifying stock receives the same allocation.
  • position *= 0.7: Scales the total long exposure to 70% of the portfolio.
  • position['SPY'] = -0.3: Assigns a fixed -30% short position in SPY. SPY is used because it is the most liquid US equity ETF and closely tracks the broad market.
  • resample='Q': Rebalances quarterly to keep turnover and transaction costs low.

Expected Behavior

  • The long/short structure provides protection during market downturns: when the broad market falls, losses on the long side are partially offset by gains on the short SPY position.
  • In strong bull markets, the short position will drag on returns, causing the strategy to underperform a fully invested long-only approach.
  • The 40% net exposure means this strategy captures roughly 40% of market beta, making it significantly less volatile than the market.
  • Value (low P/B) stocks have historically delivered a long-term premium, though the factor can experience extended periods of underperformance.
  • This strategy is suitable for investors who want to maintain exposure to value stocks but desire downside protection against broad market declines.