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The Perils of the ProShares UltraShorts

One of these days in your travels, a guy is going to show you a brand-new deck of cards on which the seal is not yet broken. Then this guy is going to offer to bet you that he can make the jack of spades jump out of this brand-new deck of cards and squirt cider in your ear. But, son, do not accept this bet, because as sure as you stand there, you're going to wind up with an ear full of cider.
-- Sky Masterson in Guys and Dolls

I was amazed at how much discussion my piece and subsequent Q&A on levered, short-sided ETFs generated, particularly for a holiday launch. We received a number of comments at RealMoney and about how this helped to explain the perplexing (under)performance of these securities -- and the chat rooms were abuzz.

For the chat-roomers, let me clear up one thing -- contrary to speculation, I am not a disgruntled loser in these things; I have never bought or sold a "bear" or "bull" levered ETF. Their construct has fatal flaws, and you can do what these set out to accomplish much more efficiently in a margin account.

In reference to the quote at the top, you will not catch me uttering, "Daddy, I've got cider in my ear," as Sky Masterson did after being hoodwinked into a bet as to whether he could get Sgt. Sarah Brown of the Save-a-Soul mission to accompany him on a dinner date to Havana, Cuba. Yet many professionals, who have been deemed "smart money," may feel like invoking that very line as they towel their ears dry.

A couple of interesting news articles hit the streets Monday, and they sadly highlight how some of the smart money has been gaffed by these. I mentioned that these products are really marketing gimmicks and not created for professionals, so I was stunned when I saw some professionals get suckered in.

Barron's current edition of "The Roundtable" has a review of the 2008 professionals' picks. At the beginning of 2008, Marc Faber made the prescient call of being short China. He recommended two ways to do so: short the iShares FTSE/Xinhua 25 Index (FXI) ETF (which was down 46.7% -- nice call) or to buy the ProShares UltraShort FTSE/Xinhua China 25 (FXP) (the double short on the same index which the FXI is long). The FXP ended up being down 57.2% ... whoops! We saw the same thing with the ProShares UltraShort Real Estate (SRS) -- the 2 times levered ultra short fund ended up doing worse than being long the very index that was down ~40%. Wrong execution of the right idea.

Don't miss "You Ask, Oberg Answers."

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