Last week I wrote about the vast proliferation of Exchange Traded Funds (ETFs) in recent years (see Part 1). At this point in time we are quickly reaching the point of “overload." For example, there are now roughly a half dozen ETFs available with which to trade the utilities sector alone in one form or another. While each fund tracks a lightly different index, the correlation between these various funds still run in about the 90% range – i.e., if you’ve seen one utility index fund, you’ve seen ‘em all. This reminds me of the late 1980s when mutual fund families decided it was best to be “all things to all people," and so in one year over 200 new “balanced” funds (i.e., some stocks, some bonds, maybe some cash) were launched. So were those new funds “more balanced” than the balanced funds already in existence? Not likely. And so it is likely too with the latest batch of ETFs getting rolled off of the assembly line. Still, as long as one is able to focus a little bit, there are many opportunities available for the brave and nimble trader.

There are now many, many sector ETFs available. Some of the most actively traded ETFs fall under the category of iShares, others are HOLDRS and others still are Vipers (the marketing people are staying up late, folks). One exciting new category to emerge in the last year comes from ProShares. The sector funds launched by ProShares offer two unique differences from most all sector ETFs that came before them – leverage and the ability to short a given sector.

Table 1 lists the available ProShares sector ETFs.

Table 1 – ProShares Sector Funds

Got a hankering for some high risk/high reward opportunities? Look no further than Table 1. Get it right and the profits accumulate more quickly than you can believe. Get it wrong and, well let’s just say that that’s when a stop-loss comes in handy. In the old days a bear market was something that most investors simply had to endure. You either rode it out or sold and sat earning interest in cash. Now you at least have the opportunity to make some very large profits while the financial markets go to heck in a hand basket.

For example, suppose that on October 9^th you had determined that all of the talk about the impending credit crisis was real and would adversely affect financial stocks. Back in the old days you could have sold your financial stocks, and if you were really bold, sold short shares of financial stocks. Now if you are bearish on a given sector you can go short an index with one simple trade (in fact, short two times the index).

On October 9, 2007 you could have bought ProShares UltraShort Financials (SKF) at 73.83, or $7,383 for a 100 shares. Just over three months later, SKF peaked intraday at 146.93 a share. Or how about ProShares UltraShort Real Estate (SRS). During the same time this leveraged short fund ran from $80 a share to a peak of $151.99. Now granted, no one would ever likely have bought and sold at exactly the right time. Nevertheless, if you can take even a meaningful slice out of a 99% or 90% gain in a little over three months time – while the bulk of the investing world is taking a beating – you’ve done something pretty remarkable. Of course, timing is the issue with these funds. Eight trading days after SKF topped out at 146.93, it hit a low of 92.40, a –38% decline in just eight days. SRS suffered a similar decline.

Chart 1 – ProShares UltraShort Financials soars as the credit crisis unfolds

Chart 2 – ProShares UltraShort Real Estate shoots higher as the housing market suffers

Summary

Before anyone decides to start trading these turbo charged shares, a bit of serious reflection would clearly appear to be in order. The bottom line is this: if you in fact have a viable timing method that is fairly accurate and the iron will to absolutely, positively cut a loss if and when the need arises, then these ETFs offer you a way to maximize your profitability in just about any market environment. If you’re thinking “maybe I’ll trade them based on my gut”, it might be time to get a new plan. To better appreciate this notion, consider Trader A and Trader B.

On 1/3/08, Trader A finally gave into the urge to “participate” in the surge of prices in the energy markets, buying ProShares Ultra Oil & Gas at 113.51. Trader B determined that the energy markets were due for a “correction” and bought ProShares UltraShort Oil & Gas at 34.74. Just twelve trading days later, Ultra Oil & Gas reached an intraday low of 70.10 and UltraShort Oil & Gas hit an intraday high of 54.60. Thus, in just twelve short (albeit, exhilarating or terrifying depending on whether you are Trader A or Trader B), Trader A lost –39% and Trader B gained +51%.

Chart 3 – UltraShort Oil & Gas, Daily Bar Chart

To paraphrase that old saying about politics, “trading leveraged long and leveraged short exchange traded funds ain’t beanbag (Okay, it doesn’t quite roll off the tongue like “politics and beanbag”, but you get the idea).

To search for previous articles written by Jay Kaeppel, please click here.

Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site

• Email This Article
• View Full HTML
• Digg This
• Delicious
• Subscribe

Recent Articles by Jay Kaeppel, Optionetics.com

• January 7, 2009
  Kaeppel's Corner: The Early January Alert
• December 31, 2008
  Kaeppel's Corner: 2009, The Year of Investing Differently
• December 24, 2008
  'Twas the Bailout Before Christmas
• December 18, 2008
  'Twas the Bailout Before Christmas
• December 17, 2008
  Kaeppel’s Corner: The Most Recession-Proof Job in the World