Inverse (Short) ETF Portfolio Update - 1/10/09

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. Now in the days leading up to Mr. Obama's inauguration, the market is falling, instead of rallying as I expected.

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. This past week, the inverse ETFs rose 6-16% as the market indices fell.

	Hedging in a Volatile Market
Inverse ETF [purchase date]	Shares	Purchase Price	Price on 1/9/09
Ultrashort Oil & Gas Proshares (DUG). [11/21/08]	100	$38.21	$24.16
Ultrashort Financial Proshares (SKF) [12/11/08]	20	$118.99	$118.46
Ultrashort Real Estate Proshares (SRS) [12/11/08]	20	$81.64	$58.36
Ultrashort Real Estate Proshares (SRS) [12/17/08]	20	$62.62	$58.36

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. At this point, I plan to 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).

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

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