UltraShort ETFs: Is there some play left?

This market has been especially frustrating for the traditionally long-focused investor, and as a favor to these types of folks who might be frightened about shorting stocks I thought I’d give them a chance to go long while taking advantage of the short side of things. How? By buying short-sighted ETFs allows one to effectively short an index by going long. As we’ve noted before, the ETF universe has exploded in recent years and there are literally hundreds (if not thousands?) of exchange traded funds that cover virtually every index imaginable–from niche industry groups to international markets, including emerging markets. The difference between a plain-wrap short ETF and an ultrashort one is leverage. Most ultrashort ETFs move twice as fast as their regular counterparts, thus enhancing returns. But of course, leverage is a double-edged sword as you can lose money faster, too, thus reaffirming the value of setting stop/losses. So what makes these ultrashort ETFs such an attractive investment strategy right now?

We’re in a bear market. Get used to it.
As I’ve been mentioning for the past couple of weeks, the market has switched into bear mode with further downside not only possible but highly probable. Why do I say that? Because of the VIX, the volatility index. The VIX has been heading up for the past month and a half, passing from bullish to bearish in the beginning of June when it crossed the 20 level. Currently it’s at 25, no where near its market capitulation level of 35 which it has touched several times in the past year. I firmly believe that we’re not going to see any type of market correction until the VIX clears the 30 level at least. An increasing VIX puts further downward pressure on the market, and I don’t think anything except for energy and perhaps materials stocks will be exempt from the carnage.

And that’s why I think buying ultrashort ETFs is still a good move. But which ones?

The Ultrashort short list
As I mentioned above, apart from anything having to do with energy or materials (and perhaps a few other commodities), even a blind monkey could pick ultrashort ETFs that will make money. The field is that good, but the charts of some of them are more compelling than others. Here’s a list of my favorite ultrashort candidates along with their long ETF counterparts for chart comparison. (Note that there can be more than one ultrashort fund per index. If there was a choice, I chose the more heavily traded fund.)

Technology (Ultrashort ETF/Long ETF): REW($64.50)/XLK($22.80). Major support on the XLK is at $20. This translates into over a 7% rise in the REW which is at $70. Major resistance is around $77 which is a 12 point move from current levels for an 18% return.

Dow Industrials (Ultrashort/Long): DXD($64.50)/DIA($113.60). The DXD made a new two-year high today. The next major stop for the DIA is at $110 which corresponds to roughly a 4 point move in the DXD (6% gain).

S&P 500 (Ultrashort/Long): SDS($66.90)/SPY($127.90). The S&P is currently sitting on minor support at 1280 (the SPY is at 128). If it breaks through this (and I think it will), the next support area is around 1235. Doing the math shows that the SDS is expected to reach close to its multi-year high of $72 for a 7% return.

Nasdaq 100 (Ultrashort/Long): QID($43.90)/QQQQ($45.75). The Q’s broke support a couple of days ago and the next stop seems to be 42. If the Qs drop to that level means that we should expect the QID to reach $49.60 (or so) for a return of over 12%.

China (Xinhua China 25 Index) (Ultrashort/Long): FXP($85.90)/FXI($130.30). The FXP has already risen over 40% since the beginning of May. It’s entering into a congestion area at 90 and if it can break through that, it may make a run to its old high of $120 which, coincidentally, is also a major support level for its long counterpart, the FXI. But even if the $120 support level holds for the FXI gives us a target price of around $99 for the FXP–a return of 15%.

Well, this is the short list. I didn’t include the SKF, the financial ultrashort, which has already zoomed up 65% since May. Today’s topping tail could signal a short-term decline, so I wouldn’t jump in here just yet (if at all). I’m going to construct an equally weighted portfolio of these five ultrashort funds today and see how we do over the next couple of months. I have two target exit dates: 1. If the VIX rises above 30, my exit date will be the day it drops back below it, and 2. If the VIX never reaches 30, I’ll exit the portfolio when it falls under 20.

It’s good to have an escape plan.

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