Saturday, January 03, 2009

Inverse (Short) ETF Portfolio Update - 1/3/09

The stock market is continues to be strange nowadays, with little reaction to all major bad news such as the Madoff $50 billion investment scam, the auto bailout bill failure, and subsequent TARP bailout of GM and Chrysler. Hopefully, the lack of volatility is an indication that a rally is beginning...

To hedge against the market falling, I have small positions of Ultrashort Real Estate Proshares (SRS), Ultrashort Financial Proshares (SKF) and Ultrashort Oil & Gas Proshares (DUG). These are inverse market index ETFs, meaning they rise when the market falls and vice versa.

Hedging in a Volatile Market
Inverse ETF [purchase date]SharesPurchase Price

Price on 1/2/09

Ultrashort Oil & Gas Proshares (DUG). [11/21/08]100

$38.21

$22.70

Ultrashort Financial Proshares (SKF)
[12/11/08]
20

$118.99

$102.05

Ultrashort Real Estate Proshares (SRS) [12/11/08]20

$81.64

$53.23

Ultrashort Real Estate Proshares (SRS) [12/17/08]20

$62.62

$53.23


I purchased these ETF because I believed they would provide some protection if the market should fall. However, upon further investigation, I learned that these ETFs can fall even if the market index declines over time, due to the ETFs being base on the daily return of the index, which Proshares customer service confirmed when I asked them about my observation. The Motley Fool has a great explanation, with an example, of how these 2X inverse ETFs may not protect against a long term decline in the index.

Based on my new learnings, I will not buy any additional inverse ETFs and look to unwind these positions, hopefully at a profit, but at a loss if needed. With the market rallying in the last three business days, these inverse ETFs have continued to fall. I planto hold them until through the first couple weeks of 2009.

Lesson learned: Don't buy derivative investments when I don't fully understand how they work, as in the case of 2X inverse ETFs.

Disclosure: At the time of publication, I own shares of the Ultrashort Real Estate Proshares (SRS) , Ultrashort Financial Proshares (SKF), and Ultrashort Oil & Gas Proshares (DUG).

For more on Reflections and Musings , check back every Saturday for a new segment.

This is not financial or investment advice. Please consult a professional advisor.

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