Some of the funds use leverage to magnify results. When the S&P falls by 1%,
Rydex Inverse S&P 500 2X
rises by 2%. The leverage can provide flexibility. Say an investor has a $1 million portfolio that tracks the S&P. To protect against losses, he could put $1 million into the regular S&P inverse fund. Or the investor could accomplish the same thing by putting $500,000 into the S&P leveraged fund and invest the rest in stocks or bonds.
Instead of buying an inverse fund, an investor could short an ETF, such as
iShares S&P 500
, which tracks the benchmark. (The SEC order did not bar shorting of ETFs.) But shorting has become increasingly cumbersome. In a typical short transaction, an investor borrows shares and then sells them. If the stock drops, the investor can repurchase the shares at a low price and book a profit.
To short a stock or ETF, a retail investor must first establish a margin account with a broker. Then the broker must borrow the shares from an investor who owns them. In recent months, it has become increasingly difficult to borrow stocks. "Because of the concerns about credit risks, some people have been restricting the shares they will lend," says Ryan Harder, a Rydex portfolio manager.
Once he succeeds in selling the borrowed shares, the short investor must monitor the position carefully. If the shares drop, potential profits climb. But if the stock rises, losses can mount. The investor could face a margin call, a demand from the broker that the client put up more collateral to back the losing position. No matter how a trade fares, it can generate plenty of paperwork and hefty brokerage fees.