I was talking with one of my co-worker today about the recent uptrend of the stock market (S&P500 has gone up by 17% since it’s lowest close of 676.53 on March 9th). He was not that optimistic. According to him, it is a bear market rally and it will go down again. “If it goes above 800, I’ll definitely buy some ultrashorts”, he said. I asked him if he’s so sure about market going down again, why doesn’t he sell his current positions and buy it again when the market is down. “I’m just buying the ultrashort as an insurance”, he responded.
This is an interesting strategy that I’ve never thought of. If you have a small position that bets against the market while the market is going up, then you can have something to sell for profit if the market goes down. And with the ultrashort, you’ll get twice the opposite of the market movement! You can then use that cash to buy securities when they are low. What if the market keeps going up? Well, in that case you basically loose your “insurance”, but rest of your portfolio should put you in a good position.
It could be a good strategy. I think the key is to have a small percentage of your portfolio in these ultrashorts; 5% or so. And I think this strategy would only work during volatile market like we are experiencing right now. If the market stays flat for a while or keeps going up, shorting would just loose money. What do you think?
Here is the link to the S&P500 ultrashort ETF if you want to explore this option.
Please note that this is merely a discussion and is not a recommendation to buy, sell, or trade securities, or to invest in any specific product.
1 Comments until now.
Your friend’s advice could not have come at a more opportune time! Today’s massive market rally has forced ultrashorts to quite attractive levels if you are looking to hedge your portfolio.
But one thing I have learned about these ultrashorts is that they are not always great hedges. For example, say I had foreseen this credit debacle back in early 2007 and bought say SKF to short the financials. One would expect such a move to have made me filthy rich, right? Far from it. During certain parts of 2008, even at times when the crisis was in full swing, this SKF would not have earned me much profit, if at all, let alone hedge against the losses on stocks I were long. The reason is the ultrashorts are leveraged ETFs with daily compounded returns (hence, negative returns can become even more negative) and therefore, tend to have some of the wildest price swings (in november 08, SKF went from a little over 100 to 300 in roughly 15 days and back below 100 in like 9 days; ditto with SRS which shorts the real estate index). Hence they are good only for quick bursts of profit-taking over short periods of time, ideally a day, according to the fine print issued by the underwriters. It’s a hedge only in the sense that you buy really low, sell really high and use the cash for reserves or reinvestment.
Good luck.
-SK(f)
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