Short ETFs: What You Should Know

| About: ProShares UltraShort (SDS)

Short-term traders love the ProShares UltraShort S&P 500 (NYSEARCA:SDS) exchange traded fund and other "inverse" bearish ETFs to speculate on market pullbacks or hedge long positions. Buy-and-hold investors, however, beware as SDS seeks to provide twice the daily inverse return of the S&P 500 index, so daily monitoring is necessary.

"On the positive side, the 0.89% fee this fund charges is less than the borrowing cost, so it can be a less expensive way to short the market. Another advantage to placing a bearish bet with this ETF as opposed to shorting individual stocks or bullish ETFs is that you cannot lose more than your original investment, although if you hold it long enough without rebalancing, you may lose your entire investment," reports Michael Rawson, in a recent Morningstar article.

SDS is one of the most frequently traded ETFs, with $300 million in assets traded every day, reports Rawson. However, due to the elevated risk and expense, SDS is a better suited fund for day traders, and those investors who can monitor it daily.

SDS seeks to provide twice the daily inverse return of the S&P 500 index. Investors may feel compelled to use this fund to take advantage of an investing idea or trend, or to use it as a hedge. Only those investors that can monitor the fund diligently should use SDS, says Rawson, or an alternative route would be to simply change asset allocation to get similar results.

Investors should also be aware that index swaps are used in this fund to get the desired returns. These are taxed at a short-term capital gains rate. When an investors sells this fund for a gain, the tax consequences are high, even when it is held for over one year.

ProShares UltraShort S&P 500

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Tisha Guerrero contributed to this article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.