Inverse (Short) ETF Portfolio Update - 2/7/09

The stock market is continues to be strange in the days after President Obama has assumed office. The market is volatile at unexpected times and surprisingly calm in the face of bad news. I believe the market action indicates that it is nearing a bottom.

To hedge against the market falling in November to December, 2008, I had purchased 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.

In mid January, 2009, I was able to sell the Ultrashort Financial Proshares and one lot of the Ultrashort Real Estate Proshares at a profit. The Ultrashort Financial Proshares continued to rise in mid January, going as high as $200 before falling back to $158.78 at the end of Janaury.

In the past week, the two remaining inverse ETFs fell as the market rallied on the expectation of Congress passing a stimulus package. I expect that these ETFs will continue to decline since the stock market may move into another short term rally.

	Hedging in a Volatile Market
Inverse ETF [purchase date]	Shares	Purchase Price	Price on 2/6/09
Ultrashort Oil & Gas Proshares (DUG). [11/21/08]	100	$38.21	$22.06
Ultrashort Financial Proshares (SKF) [12/11/08]	20	$118.99	sold 10 shares at $140.33 on 1/14/09 sold 10 shares at $165.95 on 1/16/09
Ultrashort Real Estate Proshares (SRS) [12/11/08]	20	$81.64	$54.29
Ultrashort Real Estate Proshares (SRS) [12/17/08]	20	$62.62	sold all shares at $66.82 on 1/14/09

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 based 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 other inverse ETFs and continue to unwind these positions, hopefully at a profit, but at a loss if needed. However, if the Ultrashort Financial Proshares ETF drops below $100, I may consider buying a new 20 share position, especially if I no longer own the Ultrashort Real Estate and the Ultrashort Oil & Gas ETFs.

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) , and Ultrashort Oil & Gas Proshares (DUG).

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