BULLS & BEARS: Investors have new tools to soften market whiplash

August 7, 2006

Being a super-bear or super-bull just got a lot easier and cheaper.

Until the last few weeks, if you had been bearish on the market and wanted to profit from that bearishness, you only had a few ways to play it.

One was to short an index exchange-traded fund, or ETF, in a margin account.

The second was to buy an inverse mutual fund from Rydex or Profunds.

Or, last, if you knew what you were doing, you could use an options or futures contract to profit from the downside.

But finally there's new game in town that everybody can use to profit from the upside or downside, and can use leverage, even in an IRA.

Regulators recently approved 12 new, innovative ETFs from Proshares, following a half-decade of discussions.

These ETFs give you either a short exposure to an index, a short exposure multiplied by two, or a long exposure multiplied by two to an index.

The indexes you can leverage with a point and a click are the Dow Jones industrial average, the NASDAQ 100 index, the Standard & Poor's Mid-cap 400 index, and the S&P 500 index.

Skeptical readers may be thinking, "Oh great. Now people can leverage an index in their IRA and lose money twice as fast!"

That is a risk, but the real value of these new gizmos is they give you the ability to provide an airbag for your account at a discount.

Assume you had an IRA rollover with $65,000 in stocks and $35,000 in a money market fund. You really like the stocks and want to hold them, but you think there could be a 10-percent hiccup in the market. Under this scenario, if your account hiccupped as much as the market, it would lose $6,500 in market value. But let's say that, instead of just sitting and watching the pullback, you placed half of the cash in the Ultrashort Dow 30 ETF; ticker symbol DXD. This time, when the market drops 10 percent, the airbag pops out. Your stocks are still down $6,500, but the leveraged inverse ETF has gained 20 percent for a $3,500 profit. The net of it all is your IRA is bruised and down $3,000 instead of being battered and down $6,500.

A full commitment of all the cash in the IRA would have netted you a $500 profit in the decline.

Another way to use them is to turbocharge an index bet. If you own a leveraged index ETF and the index rises 10 percent, you will profit 20 percent. Or maybe you want to take a flier and speculate.

These leveraged ETFs are also marginable, providing $4 of exposure for every $1 you speculate with. A 10-percent move in the index nets a margined buyer a 40 percent gain ... or loss. Leverage, as we all know, works both ways. It can be a wonderful salve, or a heck of a sting; so be careful with these things. Learn more at www.proshares.com.


Gilreath is co-owner of Indianapolis-based Sheaff Brock Investment Advisors, money management firm. Views expressed are his own. He can be reached at 705-5700 or daveg@sheaffbrock.com.
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