In This Year Of The Horse, Ride The Best In Our Stable: UDOW

 |  About: ProShares UltraPro Dow 30 ETF (UDOW)
by: Peter F. Way, CFA

We have urged SA readers to own the ProShares Ultra Pro (3x leveraged) Dow 30 ETF (NYSEARCA:UDOW) several times before this. They should never have been disappointed, and probably will not be this time, either.

As usual, our guidance as to timeliness of action comes from the market-makers [MMs] who help big-money fund managers shuffle volume blocks of stocks and ETFs into and out of their portfolios. The MMs usually have to commit some firm capital as a temporary position sometimes long, sometimes short, to get each deal completed at a price and time acceptable to their clients. These are usually million-dollar-and-up order tickets.

The MM firm's price-risk exposures always get hedged. What the MMs are willing to pay, and what some other MM firm's proprietary trading desk demands to provide the protection, along with the way the insurance is structured, tells just how far both buyer and seller of the coverage think the stock's price has a likely chance to go in the near future.

Hundreds of trades in hundreds of stocks and ETFs are handled this way every market day. It is what makes it possible for 4 billion shares to be traded just today. For a 252-day a year business, that's a trillion shares hurtling around, from hand to hand, between buyers and sellers. Gotta be quick, and careful, and right. The MMs usually are, making money, big money, nearly every day.

Their focus is on the big stocks, and some of the biggest are those 30 in the Dow Jones Index. The components in the index are the holdings in the UDOW ETF. The MMs know them well individually, have up-to-the moment intelligence on each right at hand as it develops, and have state-of-the-technology systems feeding them developments and research judgments on a 24 x 7 basis.

It figures they would know an ETF of the Dow 30 very well, and when the ETF sharpens the payoff potentials with a structure that levers up likely price moves to 3 times what is likely to happen to the index, the recipe for intense attention is complete.

We know how to translate their self-protective hedging actions into specific price ranges. We have been doing it since it hit the market, day by day, nearly four years. The 900+ daily forecasts the MM community has made, in the course of doing their very highly-paid jobs, leave little doubt that they have a keen, reliable insight into UDOW.

Here is what their last two years' expectations have provided for shorter-term investment guidance, when only a once a week look is drawn from the daily forecasts:

(used with permission)

The MMs know when their clients should use caution, and when they should step on the gas. They're not at all interested in telling you, but they can't help leaving tell-tale tracks as they make themselves scads of money, day by day. So we can pass on the bottom line of what they know: when prices are likely to move, which way, and by how much.

The above picture shows what has been going on, longer-term. Here is how the story has shaped up more recently, day by day:

Now each of those vertical lines is a daily fresh forecast for "tomorrow." The data in the lower right of the blue-background picture, and its repeat in the table below the graph tell what those market pros are betting on now. No, they're not flawless; you could say they've been wrong for over a week now, with lower and lower forecasts.

But how long did that continue last September-October? Then it didn't take long for the market to turn around, and that profit opportunity quickly disappeared. The time to act is when the opportunity is presented. Scaling in, with small, repeated bites, is a market pro technique that any individual investor can employ. Get what you can a bit a time, as long as it is present.

That row of data below the picture tells that an 11% upside is seen now. In the past when UDOW has looked to the MMs as it does now, it only took 29 market days to capture an average +12.4% gain on 8 previous opportunities, including the two experiences that lost practically nothing.

Please note that their lowest future expected closing price is above today's close. In terms of our metric, the Range Index, that condition is represented by a minus quantity, specifically -15 at present. It says that in terms of the $8.64 range between $92.16 and $100.90, the current price of $90.83 is -15% of that $8.64. More importantly, the $100.90 high price held to be possible by the MM community is +115% of the $8.64 range above the present price of $90.83.

Put another way, the balance between upside price change prospect and downside price exposure is pathological, since there is no apparent downside. Beside the Range Index, another way we describe the price outlook for investments is in terms of a reward-to-risk balance, where reward is upside price change, and risk is downside change, often called drawdown.

The equal balance of a 1 to 1 reward to risk condition in a Range Index would be a 50, since the RI value is a measure of that percent of the range of price possibilities now seen to be below the current price. Correspondingly, a 2 to 1 would be a RI of 33, and a 3 to 1 would be 25, and a 9 to 1 a RI of 10.

But what of a negative RI? We sidestep the philosophical distraction and simply label the reward to risk relationship 100 to 1. So in the table below that shows the price change actual experiences following all 981 prior forecasts for UDOW, the present one is indicated in magenta among the 89 in the top 100 to 1 row.

Click to enlarge

That row shows that the average actual price for all 89 of such forecasts, some 80 market days after each forecast, was +21% higher than at the day of the forecast. That is nearly twice as good a price performance as demonstrated by all 981 forecasts in the blue row, where the 80-days-after-forecast average was only up +11%. In the 1 to 10 row near the bottom (a RI of 91) the 16 instances declined an average of -7% after 80 days.

Just to keep the above table in terms that are more recognizable, and that keep the increasing time periods of the columns on an equivalent footing, here are the same outcomes expressed as annual rates of change:

Click to enlarge


UDOW is now at another of its periodic extremely favorable opportunity points in time for investors to take a long position in the shares of the ETF. The sell target of $100.90, up +11%, is seen by MMs as reachable any time in the next 3 months, and similar outlooks have been accomplished with larger gains in less than six weeks time. The odds of achievement have been at least 3 out of 4, and typical worst-case experiences in getting to a sell target have been a price drawdown of less than -4%. But the past may not be prologue, and there are no guarantees on this horse...just odds.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.