Stock Gumshoe

This is just a quick note to let you know about part of what Martin Weiss is trying to sell you as part of a subscription to his Safe Money Report (now there’s a loaded name for a newsletter, eh?).

He’s offering all kinds of stuff that’s designed to appeal to people who are terrified that the markets will go down, but one of the things he’s offering is a special report called Inverse ETF Riches for 2008-2009, a report that he thinks is a $79 value.

Here’s the sales pitch they’re throwing out:

“In this report, you’ll discover …

“How anyone can buy inverse ETFs as easily as any other stock or ETF, in any brokerage account …

“How to use these special investments to minimize losses in the stocks you can’t afford to sell now …

“How they can hand you up to $2 in profits for every $1 decline in the major indices and the weakest sectors …

“Our proprietary four-step approach to using them to help minimize your risk and maximize your profit potential …

“Our comprehensive list of 38 inverse ETFs you should be considering now, including links to the websites that tell you everything you need to know about each one of them … “

OK, so is any of that stuff secret? Well, I can’t tell you what their “proprietary four-step approach” for trading these things is, but I can answer the other questions for you:

The company that packages these Inverse ETFs, which are also called Reverse ETFs or Short ETFs, is called ProShares, and believe me, they make no effort to keep these products a secret.

How can you buy them as easy as any other stock or ETF? That one’s easy, these are just ETFs that happen to represent the reverse of an index’s return. They have stock ticker symbols, and you place buy or sell orders for them exactly the same way you buy any other stock or ETF.

How can they hand you up to $2 in profits for every $1 decline? That’s no secret, either — there are two different kinds of short or inverse ETFs, the regular Short and the UltraShort. Short ETFs give you a return that is opposite the return of the index in question, UltraShort ETFs give you a return that is twice the oopposite of the return of the index.

So if the S&P 500 goes up 5%, the S&P 500 Short ETF will go down 5% and the UltraShort version will go down 10%. If the S&P 500 goes down as you’re betting, the result is a positive return for the short ETFs in the same proportion. Not every index has both a Short and an UltraShort ETF, but many do.

And that list? The “comprehensive list of 38 inverse ETFs you should be considering now, including links to the websites that tell you everything you need to know about each one of them?”

Well, for that you can pay Martin Weiss if you want — or you can go straight to the horse’s mouth for what I would wager is the exact same information. If you want the full details about each of the 38 Short and UltraShort equity ETFs available, you can just go to the ProShares site here to see what’s available.

Yes, that’s right — this isn’t an editorially selected list of the 38 ETFs you should consider. ProShares only has 38 Short and UltraShort equity ETFs (they also have two that short bond indexes, FYI). The list includes their names, tickers, current prices and the Net Asset Value (the fair price against the index, which might sometimes be slightly different than the price the market is willing to pay) and you’ll find that each one links to a full description.

So … do you want to buy these? Well, if you want to hedge against the market, or against some holdings that you would prefer not to sell, it might make sense to bet against the market in this way. And if you just are certain that a particular sector will go down, this is one relatively easy and unleveraged way to bet on that.

For many of these indexes you could also buy puts, as you could for individual stocks, but that carries with it a very different set of risks — buying put options, which is also a way to bet that a stock or ETF will go down, means you’re betting on a particular time period, and that if you’re wrong you’ve got a good chance of losing all your money thanks to the leverage and premium that are part of almost all options trades. Being short through an ETF might feel frightening or risky, but with a regular short ETF you’re only ever going to lose as much as the long investors win, you won’t lose all your cash, absent a massive 100% move in the markets, as long as you’re not buying with borrowed money. And they trade with some liquidity, so you can usually get out of your trade more easily and at a fairer price than you can typically sell puts in an advancing makret, and you can use things like protective stop loss orders with some confidence (no guarantees, of course).

There are a couple things to think about as you consider whether or not to buy into one of these ETFs:

1) They aren’t secret. You’re not getting in on anything that lots of active and institutional traders don’t know all about. It might be a good investment, but it’s not going to make you rich by nature of its mystery.

2) They’re fairly expensive. Expense ratios are all listed on the ProShares site, all the ones I’ve looked at have annual expense ratios of .95%, which is very high for an index ETF, though of course these are very different than regular index ETFs.

3) Making emotional, rash decisions on the short side when the market is in a panic can be just as unprofitable as trying to jump on a hot stock when it’s moving up rapidly.

4) These are great tools, and like any tool, they’re best used by people who understand them. Do your research, understand how you might react to big moves up or down in these ETFs, and think about why you’re considering an inverse ETF.

And be extra careful that you are prepared for the volatility of the UltraShort ETFs — if you’ve been around the market for a long time you’re probably still conditioned to think about indexes as slow-moving diversified investments, but some of these sector UltraShort ETFs, in particular, can move extremely fast, especially in a crazy market such as we’re living through right now.

Remember, if the market changes its mind dramatically about the financials and has a huge relief rally in that sector of 12%, that means the UltraShort Financials ETF would go down by 24%, quite possibly before you had a chance to do a thing, especially if it’s another weekend bombshell. (I own a few shares of that ETF, so that’s a position that I’m in at the moment — keeps the blood flowing.)

I have no problem with Short ETFs, and like to tinker with them sometimes, but with the UltraShort Financials ETF (SKF), which is understandably the most popular at the moment, it’s not unusual to see 20% intraday moves lately. That can either spike your adrenaline and make you think you’re bulletproof, or drown you in despair, depending on which side you’re on. I like gambling, which is why I find them interesting sometimes, but make no mistake — in the short term, particularly in this environment, buying the SKF is gambling (unless you’re just hedging).

And one small note on the short financials ETFs: Remember that rule the SEC passed that said you’re not allowed to sell financial companies short? That means that ProShares is no longer creating new shares of the Short Financials (SEF) and the UltraShort Financials (SKF). You can still trade them, and there are plenty that existed before the rule changed, but since no new shares are being created, at least temporarily (the rule currently runs until October 2, but it might be extended or modified by the SEC), it’s possible that SKF and SEF might move apart from their index if demand either falls or rises significantly. So far they’re still quite close to their NAV, within less than a percent, but that may not continue next week, or into the future if the no-shorting rule is extended, as long as they’re not making new shares it’s possible that these could trade at significant premiums or discounts a la Closed End Funds.

To tell the truth, even though I like to gamble a little, I’m most comfortable talking about these ETFs as tools to hedge against long term positions that you don’t want to sell — that way, you can win either way or, if you’re committed to a few stocks, you can at least protect yourself on the downside if you happen to be wrong. You can also use them for broad sector bets, but be mindful that most sectors include both the failing companies you hear about, and plenty of successful companies you don’t — the full descriptions of these indexes will tell you which stocks are in each index. Hedging can be considered a broad thing, too — if you have a big position in S&P 500 ETFs but you’re worried that one sector will bring down the S&P, you can always put on a hedge in a Short or UltraShort sector ETF. Of course, if you’re wrong you’ll just depress your returns.

If you don’t know what I mean by hedging an existing position, a typical example would be this: You have a big position in Citigroup because you inherited it from your Grandma, or it’s in your employee retirement account, and you don’t want to sell it for tax reasons or because your boss won’t let you — if you buy a position in the UltraShort Financials ETF you can at least hedge some of that position, since if Citigroup falls that ETF is likely to spike up. There are similar examples across the sectors and market styles, if you have an outsize position in a particular industry it can be worthwhile to hedge that position with a Short or UltraShort ETF (you can also hedge individual stocks or ETFs directly by buying puts against it, but as I said that’s a time-constrained and sometimes hard-to-trade solution) — In whatever case, if you decide to hedge like this know what you’re doing, and why, and when you might want to sell, because that hedge does make your investing more expensive.

If you want to use some wild leverage, you can also buy call options on an UltraShort ETF — which adds leverage on top of leverage, and gets rid of the liquidity. Those options premiums are very high for most of these ETFs, but if you like rollercoasters and don’t vomit easily, don’t let me keep you from your fun.

So … no exciting tease today, but I’ve had a lot of folks ask me about these and forward similar emails — I hope the ProShares site gets you at least a start on understanding what they are and what you’re doing when you invest in or trade these Inverse ETFs.

Full disclosure: As of this writing I currently have a small position in the UltraShort Financials ETF (SKF) with a stop loss order in place, so I could close it at any time.

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The author will always disclose any direct long or short equity, debt or option position in any stocks written about as of the day of publication, and will not trade in any stocks mentioned for three days (72 hours) after publication. Full disclaimer is at the bottom of the page.