Using the Double-Short ETFs (QID, SDS, MZZ, DXD)

Roger Nusbaum submits: I bought shares of the double short ETF for most clients on Friday morning. The target allocation was 4% of client accounts, but that is a generic number as some got different amounts.

A big concern right here for me, and it is not being talked about a whole lot (I don't think), is the deeper inversion of the curve. I also think the end of ZIRP in Japan will continue to impact world markets.

I am not sure that the nastiness in the Middle East, in its current state, will have a lasting impact but I suppose it could escalate to draw in other countries as some have suggested.

I think the technical condition has deteriorated, as the SPX knifed back below the 200 DMA.

This is all still in the realm of 'down a little'. This trade is a small step to looking out for 'down a lot'. Cutting back some seems prudent to me. If the trade turns out to be wrong, the consequence would be some, but not a lot, of drag on the portfolio.

I tend to believe in gradual moves. If this is a bear market that ends up with a big decline there will be plenty of time to reduce further.

UPDATE: A comment from a reader:

Roger, can you do some math for me with the impact of double short etf. If the mkt goes down 10%, just to pick a number, and if you are already 30% cash, just to pick a number, then instead of your diversified portfolio going down 7% (.70x10%)....with 4% of a postion giving you 20% return, then that will yield how much reduction in your aggregate loss? Would it only be .8%? And how much double short etf would you need to buy to be neutral in this same portfolio? Roger, you certainly do not need to follow my set up. I'm just doing my best to follow it through. And, to be less disruptive to a portfolio, what are the pros and cons of buying long term put options? Good luck, Your job is indeed a hard one.

I had to read this a couple of times and I am not still not sure I got it all, but I'll try.

First, for the example we have to assume that SDS will exactly double the inverse and the the equity portfolio will exactly mirror the SPX:

Total Portfolio $100,000
Invested in Stocks $70,000
In money market $30,000

Per the example $4000 into double short ETF. The market then falls 10%. The $70,000 becomes $63,000 and the $4000 becomes $5000. The total portfolio has dropped by $6000 or 6% while the market has dropped 10%.

To be exactly neutra,l I think you would have to be 66.66% in stocks and 33.33% in the double short fund. Like John Hussman wrote recently about, all you would net would be dividends, which might not be bad. If the market does drop a lot you would need to reduce the double short because you would end u net short otherwise, and I think the question is about staying neutral.

Put options could work. If the SPX closed at 1236, which one would you buy? What about September? How far are you willing to let the market fall strike-wise? A Sept 1225 was offered at $8.80 at the close. If the market does fall will it fall before Sept expiration? If not will you roll forward?

I think options would be more complicated, tougher to manager and much easier to screw up.

Related: Shorts, Rejoice: Double-Inverse ETFs To Begin Trading Thursday

Comments

[D333GS:]

Trying to understand the the QID. Used to short the QQQQ by about X two.
If I have it right, the QID will move in the opposite direction by about twice . If the QQQQ goes down or up $1 the QID will move $2 aprox.

Is this right?

OR

does the QID move equally in the opposite direction $1 for $1 aprox BUT in your trading account you show a gain or lose of X2


Thanks

John

2007 Feb 23 05:43 AM

[Roger Nusbaum:]

on a daily basis whatever QQQQ does QID should do twice the opposite. QQQQ up 1%? QID should be down 2%.

This is daily not over long periods of time

2007 Feb 23 12:30 PM

[gofishbish:]

> This is daily not over long periods of time

Why is this? And if not, what is the expected behavior? I ask because I've held some QID for most of the year and it would appear that you loose money just by holding it. Even if the market returns to point where you bought it - QID does not.

2007 Dec 31 03:05 PM

[gofishbish:]

Actually... think I found my answer. QID is based upon QQQQ - not the Nasdaq itself and if you were to do a 1 yr comparison right now between QQQQ and the Nasdaq, you'd find (as I did) that QQQQ outperformed the index by 10% for the year. Which explains why I am hurting even worse than expected ;-) But at least now I understand it!

2007 Dec 31 04:14 PM