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I haven’t talked much about SRS and SKF in over a year, since I ditched my monster positions in them in late September ‘08. I had good reasons in the shorting ban, counterparty risk (seen when some London-listed ETFs with AIG swaps were halted), and the compounding issue.
Now, inverse ETFs are nasty, nasty instruments that can wreck you if you hold them too long or don’t use stops. That said, they do have their place as convenient tools for a market timer without an options or futures account, which for better or worse, means most traders out there. But if you’re thinking about inverse ETFs and you are trading with more than 25k, ask yourself why you don’t have a futures account.
For a pure short position, there is nothing better than futures — you can put on an unlevered position or use as much gearing as any sane person could want, with no slippage, no fees and tiny commissions. Say you have a 100k trading account and you don’t want to risk it all. That’s fine, just short a single e-mini contract. With today’s index prices NQ (Nasdaq 100) is worth 37k; ES (S&P500) is worth 56.5k; TF (Russell 2k) is worth 63.5k and YM (mini Dow) is worth 53k. Some people who will put half their account into a 2x ETF think that is safer than futures. What nonsense! 50k in SDS (-200% S&P) is like selling two 2 ES contracts, except that you pay fees to ProShares and lose money if the market doesn’t fall immediately. You even lose money if the market trends sideways — how nuts is that?
Now, a 100k account could easily be blown to bits if you decide to go all-in and short a cool million worth of S&P contacts (which you can do), but then those 3x ETFs can do the same thing to you. At least with futures you know exactly where your account is going to be at any given SPX level. With ETFs, the way the market moves is as important as where it moves.
Ok, now you know what I really think. But here, for the brave or foolish or IRA-bound, is a chart of SRS and SKF:
Source: Yahoo! FInance
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I’m not saying I’d do it, but their underlying equities (as seen by IYR for REITS and XLF for financials) are some very overbought and tiring debt-addled zombies:
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If what goes down in the next round of credit panic is worse than 2008, and it very well could be, the counterparty risk in short ETFs will be very much an issue. If the markets do crash again and these ETFs soar, it could be prudent to just take the money and run on the first hard leg down.
PEJ
January 17th, 2010 at 4:51 pm
what about shorting long etfs? like going short IWM instead of TF? You’d also collect interest on the proceeds, in an interest bearing environment (that’s what I’ve done).
Mike
January 17th, 2010 at 4:57 pm
Sure, that works fine, but you have to pay interest when you borrow the shares. One nice strategy here is not to short TWM or SPY, but to short a 2x or 3x ultra-long ETF. This way you can deploy less capital, as well as benefit from their decay, with maybe the added bonus that in an armageddon scenario the swap counterparties default and the instrument becomes worthless!
Pej
January 18th, 2010 at 1:42 am
What about buying puts on those triple leverage ETFs then? That would reduce further more your risk AND capital deployment.
Although I’m not thinking at the moment that there will be counterparty defaults at the moment (and even less that in case of default, they wouldn’t be bailed out…), I’m guessing that in your armageddon scenario, PUT contracts would not be honoured though and that they would be defaulted on?
Graphite
January 18th, 2010 at 4:42 am
If leveraged ETFs start having counterparty problems, equity options probably won’t be far behind. Although options are somewhat less esoteric and more solidly backed than some of the contracts used by the ETFs, the option clearinghouses are really not set up to withstand multiple discontinuous crash-like moves. In 1987, simple index futures (with their daily cash settlement) nearly prevented the CME from staying open.
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