Mr. Owl - I'm trying to catch up with some posts and note your excellent analysis of the banking crisis de jour. I'd urge all to read.
I've been doing some analyses lately of the new ultra short trading vehicles. These are supposed to move 2x the move in an underlying index. The index is often a surprisingly small and unrepresentative sampling of companies. What some commentators have discovered is that the math does not result in what most "investors" believe is the logical result of an "investment" in this new type of fund.
I believe most would think that this is a good way to hedge a bad market. For example, if one thinks he needs a way to hedge his real estate during these troubling times, go with SRS UltraShort Real Estate ProShares.
However, as others have pointed out with respect to these vehicles, the leverage is adjusted every day to attempt a goal of daily 2x the underlying index. Start with $10. The market index goes down 10% and theoretically, you should have 2x the inverse move or $12. Next day the index goes up 10% and you should then lose 20% of $12 or $2.40. So, the index or underlying is at the same place as where you started and, yet, you are now down .40.
That's a simplification and perhaps not technically fully accurate, but it presents a problem that the regulators have allowed to develop without enough education or disclosure and the public is jumping in. These vehicles have become very popular.
Others have commented that the setup provides for a mathematical model which does not lead to stated goals, that the indices are not necessarily representative of the supposed goal and that the underlying investments and leverage lead to results that may be more random than logical. For example, the r/e ultra short fund underlying investments may be more a play on real estate development companies than on actual movements on the price of realty over time. I've seen some talking heads on TV promote these things more as if they are a way to take advantage of falling real estate prices.
In any event, one can also buy and sell puts and calls on the underlying "stock." The net result is an extremely risky, high spread, fast moving, sometimes illiquid market where retail investors can get trapped for large sums and where large premiums often are paid to play.
For example, I've had some success writing puts and calls, largely to take advantage of the huge premiums, that result from the uncertainty and almost random movements. I take a small position because of the huge risk but have not lost yet even when my assumptions have been totally wrong. That is because the vehicle's results are so inherently uncertain, it is almost impossible for the speculator to "invest" as one traditionally uses that word. This is more legalized gambling and my friends in the professional shorting community use the arguments for this type of derivative market to proclaim that shorting should be unlimited and unfettered.
I've made some very large gains on small positions, largely by being the "house," as "investors" perhaps wrongfully think they have found a way to make money when the market is going down. It appears that long term or even a few weeks of "protection" is wishful thinking as results do seem to lead to a very wild but random walk through an untamed jungle. I am amazed that the SEC has allowed these vehicles to be traded by the investing public.
Just an opinion and not a thorough analysis. |
