Profit From the China Bubble With ProShares UltraShort ETF

The ProShares family of exchange-traded funds (ETFs) launched two new unique investments on November 8th. Investors that believe the bubble in China is about to burst or has already started to fizzle out, now have an ETF for their portfolio. The ProShares UltraShort FTSE/Xinhua China 25 ETF (FXP) will seek to provide results that are twice the inverse of the underlying index, the FTSE/China 25 Index. This would not have been the best investment in 2007, considering the iShares FTSE/Xinhua China 25 ETF (FXI) was up 96% through the first ten months of the year.

So if the underlying index was up 96%, would the investor be down 192%? No. The ETF is based on daily price movements so hypothetically the ETF could fall to the single-digits, but at that time management would either perform a reverse split on the ETF or it will drop pennies per day. It can become confusing for most investors when trying to figure out long-term performance of leveraged ETFs and FXP is no exception. What I will say, is that if you buy FXP near $80 and still own at $10 you should rethink your investment strategy.

The ProShares UltraShort MSCI Japan ETF (EWV) gives investors the same type of leveraged, inverse exposure to the Japanese market. I consider the two countries completely independent of each other and will analyze them in that manner.

China is a pure growth play with the most recent GDP reading coming in at 11.5%. The country will not be able to keep up this level of growth over the long-term, though it is in the early stages of emerging and once they become more of a world power it will only help the companies domiciled in China. On the downside, with high reward potential comes high risk. This is where FXP can be utilized. Investors looking to either hedge their current China holdings or believe China is due for a short-term pullback can use FXP on a short-term basis.

Japan is on the other end of the spectrum and can be viewed as a value play. In 2005, the Nikkei Index broke a decade-long downtrend began the most recent uptrend. After moving along smoothly the Nikkei fell 20% in the second quarter of 2006 before beginning a rally to a new multi-year high it hit in July of this year. Since that time the index has been in a new downtrend. The good news is that Japan has been making strides with higher highs on the index followed by higher lows. The one problem is that it is treading water at the end of the day and only slightly moving higher. The EWV is not nearly as attractive of an investment for me because I feel Japan will continue to move higher in the long-term and the volatility is not there like it is in China. The only way I feel EWV should be used is if an investor wants to hedge Japanese investments when the country's valuation becomes too high.

Disclosure: Author holds positions in the above-mentioned ETFs