Even Cramer Agrees: UltraShort Financial ETF Is Nothing but a Poor Trading Vehicle

There’s a lot of ranting going on. And in this instance, it’s entirely deserved. Especially when the ire is aimed at the inverse Ultra ETFs (Exchange Traded Funds). I took my shot at them months ago, when I noted that, unless your timing is perfect, you’ll get hammered.

Here’s a perfect illustration. Let’s say that you were bearish on financial stocks at the close on options expiration on November 20, 2008. Your forecast was that financials would be sharply lower three months later. Well, here it is three months later and your forecast was almost perfect. The stock market recovered for a short period; then it fell off a cliff. The XLF, which is the S&P 500 Financial ETF, is down a staggering 20% since that third Friday in November.

The marketers of the ProShares UltraShort Financial ETF (SKF) tell us that the fund earns double the amount that the financials fall. For instance, if the financials fall 1%, the fund should gain 2%. They also tell us that the relationship is highly correlated, but only over a very short time frame. Math geeks know that the relationship is only short term because of the logarithmic nature of the markets.

No matter what the reason, here’s the bottom line: had you invested in the SKF on November 20 expecting the financials to fall, you probably would be blowing your brains out now. That’s because, even though you were right about the direction of financials, and you correctly forecast that the financials would fall 20% in three months, the fund you chose to profit from such a forecast is actually DOWN … -20%. That’s right, had you made a bet expecting financials to fall utilizing this vehicle, you would have nailed the forecast and lost 20% of your money.

The index (in red) is down 20%, and the leveraged, bearish UltraShort fund (in blue) is down the same amount. You wonder how these things are allowed to continue to exist if the relationship they are supposed to have doesn’t last more than a few hours. By that definition, their only purpose is to be a trading vehicle. By the marketing company’s own admission, through its marketing and compliance materials, the 2:1 relationship is only for the day. That means it has no purpose other than to be a trading vehicle. If you utilize this for any time frame other than a day or two, the advertised relationship breaks down, as this chart proves. Because the 2:1 relationship doesn’t last more than a day, SKF cannot be used for investment purposes, or for a hedge that lasts more than a couple of days. Which brings us to this next topic.

Monday, Adam Warner of the Daily Options Report, who has blasted the leveraged “ultra” funds before, pointed out that trading volume in these things has gone berserk to the point of overwhelming the financial system. He noted that 40 million shares of SKF traded on Friday. He also speculated that there may be some “arbing” going on. That is, if SKF gets to a certain premium or discount to a basket of constituent stocks, there is an arbitrage opportunity. At the same time, there has been an explosion in SKF volume. Doing a little back of the envelope math, Adam found that ”the Travelers (TRV) volume accounted for by SKF actually exceeded the volume that actually traded in TRV.” SKF volume was comprised of a bunch of flippers who have gotten so large that the tail they’re creating is wagging the stock market dog.

A few hours later, Cramer, with whom I don’t always see eye-to-eye, blasted the leveraged financial ETFs, and noted that they are a threat to the system. He doesn’t go nuts like he has in the past. This time, he’s completely rational and he’s also dead spot on. He essentially makes similar points that Adam does: These products have become gigantic trading vehicles that allow people to exceed the Federal Reserve margin/leverage limits. And he notes that no one fully thought through the full ramifications, including the unintended use of these trading vehicles when they were approved.

Cramer then lets the company that markets these products have it. He slams them for shoddy performance and failure to live up to implied performance claims, all the while providing the trading community with a nefarious method for circumventing margin limits.

Comments

[themackattack:]

Its a short term trading vehicle (up to a week or two at most), nothing more, nothing less. Just one more tool in the tool belt -- use it properly and for the right situation, and it can be quite useful.

Of course, if you try to beat on a nail with a philips screwdriver, you won't get far either (and you might even hurt yourself).

Feb 24 06:44 AM

[copper1987:]

The Ultra ETF's are used for trdaing only. I have done very with all of them including SKF.

Cramer? Pease that circus clown was saying buy GOOG at $700 and never short as the market has dropped 7000 points in less than 2 years.
Whatever Cramer says do the opposite and you will make money.

Feb 24 08:49 AM

[The End is ...:]

Very true. Can't Cramer and the others find something better to whine about?

On Feb 24 06:44 AM TheMackAttack wrote:

>
> Its a short term trading vehicle (up to a week or two at most), nothing
> more, nothing less. Just one more tool in the tool belt -- use it
> properly and for the right situation, and it can be quite useful.
>
>
> Of course, if you try to beat on a nail with a philips screwdriver,
> you won't get far either (and you might even hurt yourself).

Feb 24 09:28 AM

[squark62:]

the author write: "I took my shot at them months ago, when I noted that, unless your TIMING is perfect, you’ll get hammered." - caps my emphasis. here's the rub i have with some of the criticism against the use of ultrashort etfs. why worry about the need for timing as if this is the only way to hedge a portfolio?

think of it this way, protect your hedge with a hedge. options traders do it all the time. instead of trying to win the lottery each day, take a more measured approach using SKF in pairs trade with UYG or SSO. i guess maybe too many people are addicted to short-term gains.

Feb 24 09:39 AM

[Doc 224899:]

No, Don, SKF if a good trading vehicle, if you know how to use it, and a poor investing vehicle. With today's volatility, Ultra Shorts are good for making gains over time periods of hours to days, or a couple of weeks at most. The math tells us they aren't good for much longer periods of time, as has been discussed in several articles, and as my personal financial adivisor told me.

Feb 24 09:49 AM

[wocojoe:]

In my opinion: Why don't you the author do something about this? Why don't you go to your State Attorney General and file a complaint? I am surprised it is not run by that honest guy, what's his name? Bernie Maddoff, it sounds like something right up his alley. I would think that anyone who has one ounce of brains and lost money investing in this so-called scam would have a good class action suit here. So why haven't any of these poor, conned, and stupid losers not sued yet? What does it take to get the SEC to follow up on media covererage of possible fraud on a grand scale? Why has this not been reported to the Different State Attorney Generals Offices? or State Regulators? The only thing worse than the gullible believing in false profits, are the I told you so's who have the proof and knowledge to prove their case, sitting back smug and doing noting to ban this. I say stop bitching and sue, bring up charges with your State Attorney General Office - it's the American way - Where are the lawyers ? Bring on the lawyers, and let the bread and circuses begin. This is just my opinion of course, I am not stupid enough, nor have enough money to dull my senses - we have the laws in place to stop this. So why don't you do something about it, NOW?

Feb 24 10:15 AM

[Marc Gerstein:]

So let me see if I understand the argument here.

1. SKF promises to deliver double the inverse of a financial index on a daily basis.

2. Someone decides to stretch the holding period from a day to about three months.

3. The three-month performance of SKF does no match double the inverse of the three-month financial index performance.

In sum . . . SKF failed to deliver on a promise they never made.

THE SWINE! Call the attorney general! Lock them up and throw away the key!!!

How dare they fail to deliver on a promise they never made.

Feb 24 11:48 AM

[jcb1st:]

What about the ProShare (positive) leveraged accounts like SSO. My financial advisor "talked" me and my son into that, and wanted me to invest even more, but I can't understand how that is going to "work" even the S&P 500 continues to fall! I'd like to see a graph reflecting that!

Feb 24 01:54 PM

[Wrenchmensch:]

Sorry Mr. Cramer: You presume (correctly) on the innocence of your audience e.g. you will help them to win using the sometimes-effective "buy-and-hold" mentality of the average mutual fun purchaser who wants a little adventure (and who has been burned badly).

SKF is a trading vehicle, and therefore a menace to all the so-called financial savants who address through the media. We appreciate your dilemma. How can you preach trading to working stiffs who will be canned if they use their computers to "trade". That reality leaves you stuck with trying to sell stock information for use in combination with "buy and hold" mentalities. In fairness to all, you should go off the air during bear market periods (after you give 3 shows on selling your stock if it goes down by 7%).

Feb 24 04:25 PM

[If U Say So:]

I think SKF if a fine trading vehicle if you are so inclined to day trade with it. Cramer primarily had a problem with what he perceives to be an all-too-ready vehicle for shorting financial stocks. While that may be true, its the same argument against short selling. I don't agree with that argument either. Shorting provides liquidity and creates better opportunities for the stronger hands who can't be shaken out of their positions so easily. If the long volume isn't there, accept it. If you're certain they're wrong and I believe longer term they are, you have to put your money where your mouth is. I don't know if Cramer is such a weak hand, but he clearly can't deal with criticism of his stock picks. I say get out of the kitchen if you can't stand the heat.

Feb 24 05:39 PM

[Fitz919:]

I'm a daytrader at heart, and prefer to make money every single day the market is open. Investors are forced to sway with every gust and breeze because the only time they can make money is when the market goes up.

Leveraged and Inverse Leveraged ETFs are the most pure daytrading tools ever invented.

Using them as pairs does no harm to our financial system. When the market goes up...you take profits. When the market goes down...you take profits.

I have never used options, or sold covered calls, or shorted a stock.

Strategies that make money when stock prices fall have been around for decades. Why wasn't Cramer ranting and raving about people buying puts. Now that companies have invented ETFs that anyone can use, and see gains when the market goes down, he's gotten all excited.

Why isn't Cramer upset about Crude Oil Trading. Now there's a scam.

Companies let you trade in and out of crude oil artificially inflating and deflating the price and never ever take posession of one drop of crude.

I think the crude oil market should exclude anyone from buying contracts who cannot take physical possession of the oil. If someone wanted to create ETFs that track the price of crude artificially...without purchasing the contracts that would be just fine.

Feb 24 07:01 PM

[squark62:]

jcb1st: the s&p 500 is extremely oversold at the moment so each day the index goes down the more risk/reward there is for holding SSO. if 2x is to much for you consider the SPY which simply tracks the s&p 500 with no leverage.


On Feb 24 01:54 PM jcb1st wrote:

> What about the ProShare (positive) leveraged accounts like SSO.
> My financial advisor "talked" me and my son into that, and wanted
> me to invest even more, but I can't understand how that is going
> to "work" even the S&P 500 continues to fall! I'd like to see
> a graph reflecting that!

Feb 24 07:54 PM

[scarbelly:]

Cramer is a trader, trader, trader so I don't understand why he can't get his hairy arms around Proshares as a trading vehicle. I've followed his "investments" on watch lists and see red, red, red. At least ProShares offer piglets a shot at the shorts after the hogs have gotten to the trough during after market and premarket trading. Is that fair? Not. It has appeared to me that big fa$t hog$ have filled the trough for the piglets from time to time only to have them pull the plug after the piglets puked in their breakfast money. SEC should either ban after market and premarket trading or expand the hours of open market trading for all porcine. Petition SEC for equal opportunity to take home the bacon!!

Feb 25 01:28 AM

[hanna biton:]

I encounter the samre prblem with URE (ultra proshares real estate )
I call the company PROSHARES to understand why the SRS the inverse is getting a dividend . but the person answering my phone was desagrable and was not capable to answer my question.

and i think that this companie who invented those proshares exactly @the high point of the market is simply abusing the investor.
all the proshares were invented exactly at THE HIGHEST ever point of the market . in order to abuse investors.

those proshares need exclusively to be inspected from the SEC otherwise ,
this is an buse to investros.

the Index $DJUSRE which those URE and SRS linked to have to go hand with hand with the index . but this is not the case . today the index is down some 73.80 % BUT the URE is down 98.2 %. and the SRS (short ) is geting also a dividend ..... THE SEC IS NEGLECTING HIS duty and need to return all his salary.

On Feb 24 07:54 PM squark62 wrote:

> jcb1st: the s&p 500 is extremely oversold at the moment so each
> day the index goes down the more risk/reward there is for holding
> SSO. if 2x is to much for you consider the SPY which simply tracks
> the s&p 500 with no leverage.

Feb 25 05:37 AM

[commodity1:]

I wonder if this type of scenario would apply to all of the leveraged ETFs on the London Exchange. Actually , I think they are called ETCs, Exchange Traded Commodities. There is one for almost every commodity, corn, sugar, soy, hogs, etc. There is a leveraged one for oil called LOIL. I dont know what the leverage percentage is, 2 times or what. But this ETC was at 90 when oil was at $140. Now its at 3.

Im not sure I understand the day fluctuations vs a 3 month interval. I mean, if oil goes from around $42 today to $62 in a year, then the LOIL should be higher. Or am I missing something? Any help? How about you Don F. , I spent a small fortune on your options program about 10 years ago.

Feb 25 10:10 PM

[Honzajs119:]

SKF does not work because of FLUCTUATION
Look at 2-day example - extreme, to show mathematics behind:

Banking index Day 0: 100
Banking index Day 1: 125 (+25%)
Banking index Day 2: 100 (-20%)

SKF Day 0: 100
SKF Day 1: 50 (-25% * 2)
SKF Day 2: 70 (+20% * 2)

You can see - banking index in back in original level, not so SKF. SKF is loosing 30%.

Ultra ETF will work on growing or falling market with very little fluctuation.





On Feb 25 10:10 PM commodity1 wrote:

> I wonder if this type of scenario would apply to all of the leveraged
> ETFs on the London Exchange. Actually , I think they are called
> ETCs, Exchange Traded Commodities. There is one for almost every
> commodity, corn, sugar, soy, hogs, etc. There is a leveraged one
> for oil called LOIL. I dont know what the leverage percentage is,
> 2 times or what. But this ETC was at 90 when oil was at $140. Now
> its at 3.
>
> Im not sure I understand the day fluctuations vs a 3 month interval.
> I mean, if oil goes from around $42 today to $62 in a year, then
> the LOIL should be higher. Or am I missing something? Any help?
> How about you Don F. , I spent a small fortune on your options program
> about 10 years ago.

Feb 26 02:23 AM

[Hottstoxx:]

I dont understand cramer. The guy has been wrong 90% of the times and he is wrong again. He has no clue how these funds work. Not only do they not contribute to extra volatility they are in fact a reflection of the general market sentiment. Secondly these funds come with warning labels. They are meant for day trading not buy and hold, compounding is a known issue. If you are holding these funds, then it simply means you are the typical blueprint investor and do NOT do your due diligence. Thirdly The notional traded by these guys in an index with a market cap of 100's of billions is in fact maybe .25% at most of daily volume. How does .25% effect a market, please tell me. Again lack of due diligence. If you dont know and you are ignorant like cramer, and just make constant blanket statements this is what happens. Cramer the guy who recommended Bear stearns a buy, wachovia a buy. This guy is a marketing genius thats all, he is not a trader, and he has no clue about the real markets. He markets himself to the people who listen. 97% of REAL wall street knows this guy is full of crap. Guys all i ask is be open minded, do your due diligence and when you do you will see these leveraged etfs are some of the best new products out there when used properly.

Feb 26 12:18 PM

[Hottstoxx:]

and another thing!!! - Why is everyone concerned about this stuff. The largest scam in world history took place last year and no one is saying anything. Instead they complain about products that help utilize the market properly. US banks stole 700 bln dollars from taxpayers. These banks exec's got paid millions upon millions for the past 4 years exploiting these garbage toxic assets, then when it all blows up in their faces they get money back so they can remain solvent, I mean cmon!!!! bernie madoff had nothing on these banks. These banks destroyed the entire financial system. They new this stuff was toxic and they made billions and millions of dollars. How about you people start complaining about that instead of things that dont really matter nore have an effect on the market. The market became volatile when lehman went under, skf, and all these otehr etfs have been around for far far longer. DO YOUR RESEARCH!!!!!!! Stop listening to cramer.

Feb 26 12:26 PM

[ursmax:]

So, Don F, you were buying something you didn't know much about, let alone understand, and got hit in the process.

Had you taken just a few minutes to at least skim the prospectus plus (especially the) supplemental material you couldn't have helped but notice the foolishness of your trade: trying to make a profit by holding any leveraged ETF for an extended period of time, especially during times of very high volatility.

But here you are, crying "foul" and blaming the fund company. It's never your fault, isn't it!

I hope you learn from this lesson, and educate yourself next time BEFORE clicking the buy button instead of whining afterwards.

Feb 28 08:49 AM