Wednesday, June 1, 2011

Day Trading/Hedging via Leveraged Short ETFs

All golfers know that a good short game requires having all kind of approach shots in their bag. One approach to shorting the market is using the double (or triple) short ETFs. Similar to a golfer hitting a flop shot over a bunker it can be challenging and should not be used all the time, but at times it is the right play. Today seemed like a day to try the challenging leveraged short ETF play.

First and foremost: it is absolutely critical that an investor understand that these leveraged short ETFS are designed to track the inverse of their benchmark on a daily basis. There are plenty of places to get an explanation of how these products work so this post won't duplicate that info. Suffice it to say these should not be consider investments. They are designed as a daily hedges against market downdrafts......(which is also a nice way of trader heaven!).

On days when it seems like panic has set in, CCI has successfully used these vehicles in the past (and unsuccessfully used them There were several days during the last "crisis" when it seemed clear that all the "big money" was heading to the exits, and this vehicle worked well. In general, if a small investor decides to get out of the market during a panic (for better or worse) they can sell something in their portfolio. However, the act of selling (and possible reentering the market) is filled with intangible, psychological challenges and tangible tax consequences. So actually it can make common sense to quickly buy and sell a leveraged short etf during a potential panic ..or at least that is a good!

With that intro, today's bad economic news seemed to start a min-panic,and the "efficient" market dropped 2.25%. CCI doesn't usually day trade but this approach is an exception. CCI successfully bought and sold the SDS (double short S&P500) today. Using "best practices" in day trading, this was done with tight, pre-defined stops (while I was out enjoying the nice weather). Unfortunately that means the position did trigger some limits and the portfolio only made about .6% on this one lot trade. Of course in the context of the market down 2.25% that is nearly a 3% over-perform for the day! Since this was a one lot trade the absolute dollar amounts are not that material, but psychologically having a winner on a down day always feel good.

While this can be justified as hedging, it also is clearly market timing at its best/worst. CCI only enters these trades on days where it seems like mini-panic has set in, and only with tight stops on the trade. This is the fourth time this year CCI has entered this type of short position, and so far the trade has made money 3 times and broke even once. So 3-0-1 YTD. That is positive, but not statistically relevant .....yet. CCI plans to keep this shot in the bag, use it again when appropriate, and hopes to save a few dollars via this approach over the year.

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