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Short Etfs Everything You Need To Know
Short Etfs Everything You Need To Know
April 24, 2012 by: Michael Johnston | includes: ADZ, DDP, DGZ, DNO, DOG, EUM, MYY, PSQ, PTD, SAGG, SBB, SH, SJB, SZO, TBF, TYBS
As the ETF universe has expanded by leaps and bounds in recent years, investors now have tools at their disposal to accomplish almost every objective. From plain vanilla stock and bond indexes to hyper-targeted regional and sector funds, there are ETFs to bet on just about every asset class. And there are also a number of ETFs that can be used to bet against certain asset asset classes, which can be powerful tools for turning a profit in the types of environments that generally bring a sea of red ink to portfolio statements. Inverse ETFs, also known as short ETFs, have become extremely popular for a wide variety of objectives, including as hedging tools and vehicles for speculating on declines in value.
Day 1 $100.00 Day 2 $105.00 Day 3 $99.75 Day 4 $104.74 Day 5 $99.50 Day 6 $104.48 Day 7 $99.25 Day 8 $104.21 Day 9 $99.00 Day 10$103.95
After ten days, the index is down about 1.24%. Now consider an inverse ETF linked to that index, meaning that the product seeks to deliver daily results corresponding to 100% of the underlying index. The performance of that ETF would look something like this: Day Opening ValueChangeClosing Value -5.0% 5.0% -5.0% $95.00 $99.75 $94.76
Day 4 $94.76 Day 5 $99.50 Day 6 $94.53 Day 7 $99.25 Day 8 $94.29 Day 9 $99.00 Day 10$94.05
If you expected this inverse ETF to be up slightly (since the underlying index was down since purchase), you might be disappointed. After ten days, the inverse ETF is also down 1.24%, which occurs because of the volatility in the underlying index. When markets seesaw back and forth between gains and losses, inverse ETFs can experience some return erosion. Thats because ahead of a winning session for the inverse ETF, exposure is decreased (through a loss in the previous session), and vice versa. In back-and-forth environments, the daily reset works against these funds. Its also extremely important to note that the compounding of returns doesnt always work against investors in short ETFs. Consider a trending market where the underlying index steadily loses ground: Day Opening ValueChangeClosing Value -5.0% -5.0% -5.0% -5.0% -5.0% -5.0% -5.0% -5.0% -5.0% -5.0% $95.00 $90.25 $85.74 $81.45 $77.38 $73.51 $69.83 $66.34 $63.02 $59.87
Day 1 $100.00 Day 2 $95.00 Day 3 $90.25 Day 4 $85.74 Day 5 $81.45 Day 6 $77.38 Day 7 $73.51 Day 8 $69.83 Day 9 $66.34 Day 10$63.02
After ten sessions, the index is down about 40%. But the inverse ETF linked to this index would end up posting a gain much larger than 40%: Day Opening ValueChangeClosing Value 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% $105.00 $110.25 $115.76 $121.55 $127.63 $134.01 $140.71 $147.75 $155.13 $162.89
Day 1 $100.00 Day 2 $105.00 Day 3 $110.25 Day 4 $115.76 Day 5 $121.55 Day 6 $127.63 Day 7 $134.01 Day 8 $140.71 Day 9 $147.75 Day 10$155.13
In this case, the daily compounding of returns gives a significant boost to the inverse ETF, which realizes a gain that is considerably larger than the decline in the index. Thats because as the index declines, the value of the short ETF increases. Each subsequent daily gain for the short ETF is then applied to a larger and larger base of assets, which results in a very favorable compounding of returns.
Specifically, PowerShares and Deutsche Bank offer a number of ETNs that seek to deliver results equal to -100% of indexes comprised of commodity futures over the course of a month. These products wont be impacted by the direction of the underlying index between reset periods, meaning that the impact of day-to-day volatility wont result in eroded or enhanced returns as illustrated above. With monthly inverse ETNs, it should be understood that the target multiple (i.e., -1x) applies only at the start of the month, and will generally change as the month progresses. In other words, investors who buy in mid-month to a product such as the PowerShares DB Gold Short ETN (DGZ) could be achieving effective leverage for the remainder of the month that is greater or less than -100%. At the end of each month, that leverage is reset and DGZ will begin its objective over again (i.e., seeking to deliver inverse exposure over the next calendar month).
Crude Oil: United States Short Oil Fund (DNO) and PowerShares DB Crude Oil Short ETN (SZO) Base Metals: PowerShares DB Base Metals Short ETN (BOS) Platinum: E-TRACS UBS Short Platinum ETN (PTD) Agriculture: PowerShares DB Agriculture Short ETN (ADZ) Disclosure: No positions at time of writing. Click here to read the original article on ETFdb.com.