Are ProShares Ultra ETFs Used As Hedging Devices By Money Managers?

The ProShares Ultra ETFs enable traders and investors to leverage the movements of the major equity indices. For each 1% that an index moves, these ETFs will move 2%. This provides ETF traders with a degree of leverage normally associated with the trading of futures. Note that a pattern daytrader who qualifies for 4x leverage can reach 8x with the Ultra ETFs.

A unique feature of the Ultra ETFs is that they include separate trading instruments for long and short market exposure. By buying an inverse [short] ETF, a trader makes 2% when the underlying index falls by 1%. The non-inverse [long] Ultra ETF, of course, would rise 2% if the market rises by 1%.

Here are the symbols for the three most liquid Ultra ETFs:

NASDAQ 100: (QLD) [2x long]; (QID) [2x short]
S&P 500: (SSO) [2x long]; (SDS) [2x short]
Dow 30: (DDM) [2x long]; (DXD_ [2x short]

My initial idea was to compare volumes for the long vs. short Ultra ETFs to see if they functioned like call volume and put volume among options. In other words, by tracking participation in the Ultra ETFs, we might have a new sentiment indicator.

I'll save that idea for a later date, however. My first look suggested that something else is up with the Ultra ETFs: total volume. But not just all volume: volume in the inverse [short] ETFs. Check it out:

I went back to 7/13/06, which is when I show trading histories for the three Ultra ETFs above [N = 110 trading days]. I then compared the average volumes for the ETFs for the first half of the sample and for the second half. Here's what I found:

NASDAQ long (QLD) volume: up 51%
NASDAQ short (QID) volume: up 217%

S&P 500 long (SSO) volume: up 15%
S&P 500 short (SDS) volume: up 69%

Dow 30 long (DDM) volume: down 29%
Dow 30 short (DXD) volume: up 88%

Clearly, we're seeing much more interest in the short product than the long one, an interesting finding in a rising market.

What's more is that this interest is correlated across the Ultra ETFs. I went back to November 1st, which is roughly when we first saw a burst of new volume in the short products, and correlated the daily volumes in the inverse Ultras. The correlation between the NASDAQ inverse volume (QID) and the S&P 500 inverse volume (SDS) was .60. The correlation between the NASDAQ inverse volume (QID) and the Dow inverse volume (DXD) was .87. The correlation between the S&P 500 inverse volume (SDS) and the Dow inverse volume (DXD) was .43. All are healthy, positive correlations. This suggests that when there is buying interest in one inverse ETF, there tends to be buying interest in the others.

Correlations in the daily volume of the long ETFs is also positive and significant: around .50-.60.

What are we to make of the growing interest in the inverse ETFs and the correlated volumes of all six of these Ultra ETFs?

My take is that they are being used as hedging devices by money managers. Many managers who have been buying stocks like banshees this fall have been hedging their bets with these Ultra inverse products. They are getting the best of both worlds: they can say that they participated in the rally and they can extend their stock ownership over longer [capital gains] periods, while at the same time hedging their general market risk.

Over the last five days of relative market strength, volume in the inverse NASDAQ product has exceeded volume in the long product by 5:1. Volume in the inverse S&P ETF has exceeded volume in the long product by over 3:1. There have been no dips in the ratios of short:long volumes in the Ultra ETFs as there have been among equity put/call options.

Bottom line: At least among some money managers, their bullishness may be a mile wide and an inch deep. At the same time they're buying stocks for year end gains, they're making sure their tails are covered. Other managers may be more selective in their bullishness, preferring specific issues, but protecting themselves from overall market risk. In any event, in the Ultra ETFs, we have an interesting tool for examining the behavior of these managers. As the market has broken to new highs, they've stepped up their participation in the inverse ETF market.