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Hedging With Spread ETFs

Stocks in this article: FSE FSU FOL FSG FSA

NEW YORK ( TheStreet) -- One of the positive attributes of the ETF industry is that it offers access to segments of the market and sophisticated strategies that would not be easily accessible for the majority of market participants. The most recent product line from the "sophisticated strategies" realm comes in the form of so-called spread ETFs from FactorShares.

  • FactorShares 2X: S&P 500 Bull/T-Bond Bear (FSE)
  • FactorShares 2X: S&P 500 Bull/US Dollar Bear (FSU)
  • FactorShares 2X: Oil Bull/S&P 500 Bear (FOL)
  • FactorShares 2X: Gold Bull/S&P 500 Bear (FSG)
  • FactorShares 2X: T-Bond Bull/S&P 500 Bear (FSA)
  • The basic idea is that the funds capture the spread between the asset classes listed in the name of the fund. For example the 2X: S&P 500 Bull/U.S. Dollar Bear would go up when the S&P 500 outperforms the U.S. dollar. This could occur by virtue of SPX going up when the dollar goes down, the SPX going up more than how much the dollar goes up or the SPX going down less than the dollar -- any of those scenarios and FSU would go up.

    Going a little deeper, all of the funds are levered 2 to 1 by the use of futures contracts such that if the S&P 500 outperforms the U.S. dollar by 1% the S&P 500 Bull/U.S. Dollar Bear should go up by 2%. Given some of the huge moves lately in crude oil, the 2X: Oil Bull/S&P 500 Bear stands to come out of the blocks as being very popular and very volatile should the news moving that market persist. The expense ratio of the funds is 0.75%.

    Another point of understanding is that these funds offer a daily reset, their respective objectives are on a daily basis which requires the buying or selling of futures on either side of the spread to have the best chance of meeting the daily objective for each fund. Assuming FactorShares can execute the daily reset correctly then the funds should do what they are supposed to do on a given day. As we have seen with leveraged funds from other providers, this does not mean that these funds will capture their stated objective over any longer period of time.

    The most glaring example of a fund "not working" over a long period of time might be from 2008 when the iShares DJ US Real Estate Fund (IYR) was down 44% and the ProShares Ultra Short Real Estate (SRS) was down 52%. However, over the last 12 months, IYR was up 36% and SRS was down 61% which is pretty close. The point here is that there is no way to know what a levered fund will do over any time frame longer than the stated objective, it all depends on the combination of up and down days which is of course not knowable in advance.

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