UltraShort ETFs: Is Betting Against the Dow Still the Way to Go?

Through the first 10 months of 2008, you could have made 40% by double shorting the Dow Jones Industrials (^DJI). That's a handsome profit in a year when many investors suffered losses of 30%, 40%, even 50%!

As phenomenal as a 40% gain is, "ultra-shorting" has its flaws. The ProShares UltraShort Dow (DXD) seeks twice the inverse of the daily performance of the Dow Jones Industrial Average. The Dow was down 30% in the first 10 months, so DXD should have registered a 60% gain, right?

Twice the inverse, or 2x on the short side, has always been a challenge for the ETF world. I have warned in the past that UltraLong ETFs and UltraShort ETFs are more likely to return 1.5% of the stated goal due to the leverage that's required to surpass a 1:1 relationship. Due to that leverage, ultra-vehicles typically increase or decrease more than the value of any increase or decrease in an underlying index, effectively magnifying tracking errors.

Does someone who made 40% on an investment like DXD really need to whine? Maybe not... but the 1:1 ProShares Short Dow (DOG) achieved its stated goal of 30%. If one takes twice the risk with DXD, you'd think he/she should have gotten closer to 60%. (A 20-percentage point tracking error is nothing to sneeze at!)

In actuality, however, I am interested in looking ahead. Does "ultra-shorting" of the Dow still make sense, after the crash of 2008? Are the markets staging a valuation-based recovery, in spite of a worsening economic picture?

According to the the Stock Trader's Almanac, October is the month that killed many of the worst bear markets in history. The awful bottoms of 1966, 1974, 1987, 1990, and 2002 marked the end of some of the most egregious times in stock market memory. One does wonder if the hallowed month of October will be remembered as having ended the 2008 bear.

It's not that we have anything but silver linings to look forward to, economically speaking. Yet stock markets advance long before we see any tangible evidence of happier consumers or confident businesses.

To that end, one might wonder if the surge of the last trading week in October marked a turning points of sorts. For the first time in a month DXD fell below its 50-day moving average. That may not be saying much; nevertheless, it is the closest thing to evidence that the best, not the worst, is yet to come.

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Comments

[NOWHEREMAN:]

Of the Bear Market Dates given, none, not a single one involved a financial crisis or the the bursting of 3 Bubbles virtually simultaneously. 4 if you consider the DOW's move.

The nearest approximation is the Great D itself which took 4 years to find a bottom. Bear Market rallies are common, I would think another 10% on the S&P is possible. But when push comes to shove, the stock decline so far has not been Recession driven. The normal unemployment declines associated with recessions are about to commence. and the normal recession associated stock market declines will accompany it.

A lot of cheering occurred when the October 10th lows held for the DOW and S&P, no one mentioned that the NYSE went to a new low.

2008 Nov 04 08:38 AM

[Susan:]

Not to argue if this is a bottom or not, just to correct misinformation.

It is not true that the Great Depression bear market "took 4 years to find a bottom".

The stock market bottomed on July 8, 1932. About 2.5 years after the peak. This market bottom came more than a year before GDP started to improve and many years before the broader economy great-depression was over.

en.wikipedia.org/wiki/...

2008 Nov 04 01:19 PM

[Lynn:]

Double shorting an index on a daily basis does not necessarily double the negative return of the index over the long term. For example, if the index drops 10% on 2 consecutive days: 100 -> 90 -> 81 The index falls 19%. If the double short ETF rises 20% on 2 consecutive days: 100 -> 120 -> 144. It rises 44% (not 38%).

2008 Nov 04 06:32 PM

[Lynn:]

If you're interested in double shorting, check out EEV, an ultra-short Emerging Market ETF. In the past month it has fallen from $207 to $74. I purchased shares today. I didn't expect to see it at this level anytime soon.

2008 Nov 04 06:37 PM

[300m:]

Thanks for pointing this one out.
Why the sharp swing in a few days.


On Nov 04 06:37 PM Lynn wrote:

> If you're interested in double shorting, check out EEV, an ultra-short
> Emerging Market ETF. In the past month it has fallen from $207 to
> $74. I purchased shares today. I didn't expect to see it at this
> level anytime soon.

2008 Nov 04 09:16 PM

[Kunst:]

Ultrashorts have been very good to me this year. I'm not particularly concerned about the 2:1 issue. They go in the direction they are supposed to, and they return well better than a straight index investment. As volatile as they are, you can make or lose a lot of money in a hurry. EEV (double-short emerging markets) was down 40% in ONE DAY recently. On the other hand, it was up 37% for me during the October 6-10 meltdown week. It will be a good bet at some point, but not right now.

That said, I'm out of ultrashorts at this time. We're in a bounce. Go ahead and play it. I bought DIG (double-long oil/gas companies) on 10/23 and it's up 38% in that week and a half. When oil was coming down, DUG (ultrashort oil/gas) was a big winner. You have to get the direction right if you are going to play the ultra/short game. I put a 10% stop loss on all U/S purchases to avoid catastrophe.

I'm betting on an up-trend for the time being. I don't think we have seen THE bottom yet, but short term I think things are heading up. The trick is to see the next big downturn coming before it rolls over you.

2008 Nov 04 10:47 PM

[applesauce:]

Where do you buy the fortune teeling glasses to see the markets short term direction? I'll play blackjack.

2008 Nov 20 10:02 AM