Sentiment

Stocks are flat in a day of quiet trading Wednesday. The early earnings news was mixed. While Costco (COST) helped the retail sector with better-than-expected numbers, Yum Brands (YUM) and Monsanto (MON) suffered some post-earnings weakness. Investors now wait for Alcoa (AA) to unofficially kick off the earnings reporting season after the closing bell.

Meanwhile, the economic calendar remains light until weekly jobless claims and wholesale inventories Thursday morning. The next batch of meaningful data doesn't hit until retail sales next Wednesday. (However, same store sales from a number of retailers should grab some attention tomorrow morning.)

By Chris McKhann

Traders were snapping up calls yesterday in the UltraShort Basic Materials ETF.

By Chris.McKhann

Traders were snapping up calls Tuesday in the UltraShort Basic Materials ETF (SMN).

As promised in my previous post, Why I Sell Put Options (Part I), in which I shared why I never set these types of orders and my reasoning, here is Part II. In this post I will show you the benefit of writing naked put options on 40 popular leveraged ETFs. To understand this post you'll need somewhat of a background in stock options. To learn more about options and, how options can help protect your portfolio, and allow you to speculate with less money up front click here.

If you're finding this post for the first time and don't know the benefits of selling put options compared to setting market and limit orders, you may find it valuable to read Part I. If you're following up Part I, you'll notice writing naked puts on these leveraged ETF's bring much greater premiums.

As posted on my blog July 11, 2009, after reading a lot of blog posts and comments, tweets on twitter, Facebook comments, and emails, I decided it was time to figure out if there was any real decay behind the leveraged ETFs, both long and short. I wanted to revisit this issue of the double and triple leveraged ETFs, and why investors should stay away from them, and to clear up some confusion. With the popularity of ETFs came these funds which use 200% and 300% leverage. Yes in any steady trend they can grow like weeds, but in a correction they will give back much of their gains. This is simple, and basic math.

First of all, these are extremely risky, and investors shouldn't hold on to any leveraged ETF(s) for the "long run", they are almost sure to lose money. These instruments are ideal for traders not investors!

As recently charted in my blog post here, I believed (and still believe) the market is due for a correction. The chart is a clear head and shoulders pattern of the S&P 500 SPDR (SPY). Some of the ways I've been hedging my portfolio, is by using the leveraged short ETFs.

One strategy I've been using on these short ETFs is the Buy/Write option strategy, which hedges my overall portfolio on the downside, and gives me protection on the short position in case the market moves higher.

With just 10 days left until the option expiration, I have crunched the numbers on some of the most popular leveraged ETFs and it looks as if they're getting some summer heat. I am the first to admit that I think these ETFs are only for traders (and are an investor's nightmare), but they are so volatile, and bring such great premiums, it is hard for a trader of options like me to resist. A very short hold of 10 days could yield you a nice return considering it is only for ten days (crunch the numbers on an annual basis).

I have developed several strategies with these leveraged ETFs which seem to return steady profits month after month, and I usually wait to implement them within the two week expiration period.

Virtually all the financial press has stated that for the current rally to continue (or at the very least not to collapse) the “less bad” analysis is no longer good enough; starting this coming week, investors must see positive progress rather than the “less bad” optimism.

Each week, I like to publish the past week's hottest ETFs to share some new trends and niche ETFs out there and give investors some new ideas. For this week, short leveraged ETFs were extremely hot in the energy and emerging markets sectors especially.

I always caution that the leveraged ETFs carry substantial risks that aren't intuitive to prospective investors that haven't researched them fully due to daily rebalancing among other things. With the market volatility continuing to ensue and geopolitics heating up, cautious investors may also want to consider more stable, predictable returns in Structured Notes Products or other alternative investments to account for at least part of their portfolios.

This is the 4th Quarter 2008 edition of our ongoing hedge fund portfolio tracking series. Before reading this update, make sure you check out the Hedge Fund 13F filings preface.

Next up is John Burbank's Passport Capital. This is the first time we've covered Passport's filings, so let's get to some quick background.

When you talk to enough people -- advisers, individual investors, day traders, blue and white collar professionals -- there's a general distrust of lower oil prices. "Maybe they won't go through the roof like before," they collectively say, "but prices are definitely going to go much higher."

Dear Fellow Investor,

Shopping for a crisis to trade? Take your pick, we’ve had some dandies: family real estate; local restaurants and retail stores; commercial real estate; auto industry; banks; and every corporation with a lobbyist strong enough to get itself a TBTF (too big to fail) award from Congress.

During these past few months of turbulence and bearish trends in the market, I’ve heard increasing interest in the new classes of short – and double short – ETFs. An attractive premise: make money on the downward moves, even if you’re not able to short or aren’t able to locate shares, and with relatively low management fees, they’re a much more attractive option than traditional short selling or put options.

However, there’s a very significant yet very subtle cost to holding these ETFs. This cost, while explained in the prospectus and in a handful of posts and comments on Seeking Alpha, is not well understood by many.

by Matthew Hougan

ProShares announced distributions on 35 of its 76 ETFs on December 22, including all but three of its inverse equity ETFs, which aim to deliver either -100% or -200% of the daily return of a benchmark index.

Owners of ProShares Short ETFs got a rude awakening this morning when short-term capital gains went ex for their ETFs. And they were huge! Usually funds give investors a little time to make a decision if they want to sell the fund before the ex-date, but ProShares announced the gains yesterday after the close. This didn't allow owners to do anything but be forced to pay the short-term capital gains tax on their shares.

There's definitely a few traders out there who bought these as a short-term play in a taxable account in recent days that are now stuck paying big capital gains taxes on them. Next time ProShares may want to give investors more time between the declaration and the ex-date.

Recent market turmoil and volatility has popularized short ETFs to nearly epic proportions. This meteoric rise in visibility provides an occasion for closer examination of five of the earliest of these funds, designed by ProShares in early 2007 to give investors short strategies in single sectors. ProShares launched the 22 sector pairs simultaneously, and Ultra Short Financials (SKF), Ultra Short Real Estate (SRS), Ultra Short Basic Materials (SMN), and Ultra Short Oil & Gas (DUG) currently have the highest three-month average daily trading volume out of the batch, all averaging well over a million shares per day. The ProShares Ultra Short sector funds are unique strategies that require unique consideration before investment. While the recent attention paid to SKF, SRS, SMN, and DUG has increased the perception of their accessibility, investors should examine the funds in relation to their “big picture” strategies and weigh the unique risks and rewards involved, before diving into the short end of the ETF pool.

ProShares sector ETFs were designed as pairs of strategies to track underlying Dow Jones formulated sector indexes. The ultra long ETF of each index would provide investors with a 200% exposure to the index while the ultra short strategy would offer a negative 200% exposure. The most highly traded sector ETF from ProShares, SKF, is based off the Dow Jones U.S. Financials Index (IYF) and has a corresponding ultra long ETF, UYG. The popularity of the ProShares ultra short products can be traced to the inherent riskiness of selling short equities in an open market, thereby exposing oneself to unlimited potential downside if the equity price goes up.

With the most recent two day crash in the Dow Industrials average, we are once again poised at the precipice of oblivion. Two important dominos have been toppled in the past two days. On Wednesday, the Dow closed below the psychological mark of 8000. Granted, the 7997.28 level was not the most pronounced of breaches, but it is worth noting.

However, Thursday, we solidified the drop below 8000 and blew right through the October 10th low of 7773.71 going all the way down to 7552.29. In totality, the listed market has now lost approximately half of its value – in 12 months.

While it would be easy to digress into an analysis of the sheer magnitude of the losses over the past year, it is perhaps more worthwhile to take a look at some of the different investment themes that have been prevalent over the past year and see how they’ve fared. This is an important exercise since there is still plenty of fuel for more declines, but at the same time there are also overriding fundamentals that will drive things moving forward.

While it is very true that virtually every possible portfolio has in some way been affected by the liquidation over the past six months, it is important to note that some areas have done much better than others even though, in most cases, this still means some sort of loss. Hedging strategies can be used to mitigate such losses. The obvious drawback of hedging strategies is that they tend to mitigate gains during times of upward price movements.

Another important consideration in any portfolio is dividends. In the three sample themes we’ve constructed, we provide the returns with and without dividends. There is an old investing adage with regard to dividends that goes something like “If you’re going to have to wait, you might as well get paid for doing it.” The past year has been a shining example of this logic. For those investors who chose to try to ride out the current situation, dividends have provided a nice cushion. The biggest problem with dividends is that they’re being cut all over the place. A drastic example of this would be the financial stocks. In many cases, dividends have not only been cut, but eliminated altogether.

Because of this reality, it is important to look not only at the current and prior dividends, but whether or not the cash flow will exist to support future dividends. A good example of this analysis would be the Canadian Energy Trusts. A good many of the Trusts are paying the same distributions now as they were when oil was $60/bbl on the way up. And they paid those same distributions even when oil was $150/bbl. The obvious conclusion would be that the funds exist to maintain current levels. However, analysis of the cash flow of these firms is required to either support or refute the ability to continue distributions at current levels.

To construct our exercise, we’ll take a look at three major themes that have been prevalent over the past year: Consumer Staples, Energy, and Basic Materials. The securities selected were not necessarily part of the S&P Sector Index, but rather they were companies that have been talked about in the media and financial websites, and therefore, were likely to make it into many portfolios. While it would be easy to point to November 2007 price levels, May’s levels more completely encompass the rally in the U.S. Dollar, which has been an important direct and indirect driver in the price of many of these stocks.

click to enlarge

There was some feedback yesterday’s image was a little over-the-top. So, I’ll be a good boy today and not try to offend the sensitive among us since the markets are offensive enough, right?

Though I remain firmly in the inflationist camp in terms of how this economic crisis will unfold -- meaning I expect rising consumer prices, rather than falling asset prices, to be the primary source of the economic crisis (see my previous SeekingAlpha article on this) -- there is no denying we are seeing all the signs of deflation at the moment: MZM is contracting, equities markets are collapsing, the dollar is strengthening, and demand for US government treasuries is very high.

So what's an optimal portfolio for this bout of deflation look like?

On July 10, 2008, Dow Chemical (DOW) announced that it would be buying Rohm and Haas (ROH), an American chemical company, at 78 dollars a share, in cash. The transaction is scheduled to be consummated on January 15, 2009. However, because of the uncertainty in the financial markets, Rohm and Haas has been trading downward.

You can find the most recent spread on this deal getting done into double digit territory here. Why is the spread so wide? I can give you five factors off the top of my head.