UltraShorts and the Fall of the Uptick Rule

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I had mentioned in one of my early articles on levered short-side ETFs that I thought it would be tough to reinstate the uptick rule with these products outstanding. I never really thought much more about it beyond that one fleeting sentence. Revisiting the thought now, though, I wonder if the massive proliferation of these vehicles would have ever been possible had the uptick rule not been eliminated to begin with. (Don't miss "Uptick Rule: Meaningful or Meaningless?")

This week [Feb. 23-27] on "Mad Money," Jim Cramer showed a clip of Fed Chairman Ben Bernanke's Humphrey-Hawkins testimony. Bernanke said that, if asked, he would advise SEC Chair Mary Schapiro that there may be merit to the concept of bringing back the uptick rule.

While the clip aired, a line flashed across the screen stating that the uptick rule was eliminated in 2007. That got me thinking a little bit about the timing -- I frankly couldn't believe the uptick rule had only been gone for less than two years. Please note, I am not a conspiracy theorist at all, but I was interested in reconstructing the time frame around the growth in levered and short-side ETFs and the elimination if the uptick rule.

ProShares, "the world's largest provider of short and leveraged funds," launched its first Ultra Funds (two times levered) and Short Funds in June of 2006. In July of 2006, it launched its first UltraShort (two times levered short) funds. These initial funds were based on broad indices -- the Dow Jones Industrial Average, the S&P 500, the Nasdaq 100 and the S&P Mid Cap 400. All of these indices had active futures markets at that time, which made the hedging of these products relatively easy, and such hedging would create minimal market disruption.

Then in January and February 2007, ProShares expanded its product offerings to include Ultra/Short/UltraShort Funds based on the Russell 2000, the Russell 1000 Value and 1000 Growth, the S&P Small Cap 600 and a few other broad indices, most of which had futures or could have been hedged using a simple beta in relation to the futures contracts. ProShares also launched a series of Ultra/Short/UltraShort products on 11 specific sectors that did not have active futures contracts and would have been much more difficult to hedge using a simple beta vs. a broad index future.