Why Short Sector ETFs Aren't So Smart

Hmmm ... providing leverage and easy access to shorting the market ... that doesn't exactly sound like promoting market integrity and curbing excess volatility now, does it? The fact that so much expected return on these instruments gets eaten away by the volatility should tell you something about their efficacy.

The magnified volatility has also rendered moot many long standing market practices -- for instance, with these things it would be very difficult to reinstate the uptick rule, and they make it difficult to regulate naked short-selling, because "It's as simple as buying a stock." Furthermore, for those who follow technical analysis, cycles become much more compressed, and Fibonacci levels are no longer sacred because there is no speed governor when indiscriminate two-times and three-times levered index products are involved (and this counts in up markets just as much as in down markets) -- thus, "signals" really aren't signaling anything.

These levered and short sided ETFs are an endless series of paradoxes. They are set up to benefit from market moves, but the more volatility, the less accurate they are in achieving that objective. They market themselves as an easy way to provide sophisticated trading strategies, yet the true sophisticated investor can implement more effective trading strategies themselves. They do their job following daily moves, yet they make for a lousy long term hedge or trade. They offer the layman investor a chance to protect against volatility, yet they help contribute to and exacerbate that volatility because of their construct.

The double-levered short financials ETF is backed by -- you guessed it -- a swap with a financial. Despite having margin requirements to "promote market integrity and curb excessive volatility," these somehow have been allowed to proliferate in the market. And the biggest paradox of all is that you could have been spot-on accurate with your bearish call, yet still ended up in the red.

I realize some may say, "I hear you on that, but these just make it so easy for me to implement my strategy." OK, maybe so. But if you would have just been short the two-times long Ultra Real Estate instead of long the two-times-short UltraShort Real Estate since the beginning of the year, you'd have three times as much capital in your account right now. That's some price to pay for ease of use! At least the offering documentss state, "There is no guarantee [these products] will achieve their investment objective." You can say that again.

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