Another Way To Look At FAZ, FAS, SKF, UYG

in other words, leveraged financials ETFs. These two charts are the area charts, plotting the weekly combined price of SKF (double short financial) and UYG (double long financial) for the top chart, and of FAZ (triple short financial) and FAS (triple long financial).



Even ignoring the spikes, SKF+UYG's current price level is less than 1/2 of December 08 level. FAZ+FAS's current price level is less than 1/3 of December 08 level. So, if you are not a day trader, the winning long-term trade for these leveraged ETFs since December 08 would have been to short ALL.

If it's any comfort, unleveraged financial ETF combo hasn't fared that well either. The weekly combined price of SEF (unleveraged financial) and XLF (unleveraged financial) for the same duration shows a decline of about 25%, mostly due to the decrease in SEF.

Possible Future for FAZ

by popular request...

Ran the same numbers for FAZ, triple-short financial ETF, a la "Possible Future for SKF" (previous post). Comparison of FAZ, IYF, and BKX, with stock prices and index value as of May 22.

I just did the Case 5, where BKX would run all the way to Sept-Oct 08 level, and reverse all the way back to March low. FAZ would be a 10-bagger if you caught it at top of BKX, and if BKX did indeed drop back down to March low. Otherwise, there will be easier money to be made elsewhere (until P3 hits... for more, go to ex-SKFer Daneric's blog).



The best case for FAZ would still be the one in which BKX corrects right now to March low without going up much. Then FAZ would be about $20.

Possible Future for SKF

Today it's not a graphical chart, but a spreadsheet I did a while back ago (May 22, actually) and modified some today. I have discussed how leveraged ETFs, long or short, do not perform as you may think (unless you read the fine print), in these posts.

I made this spreadsheet back when there was still a lot of talk of imminent market correction and retesting of March low. BKX is the Philadelphia Bank Index. SKF is Ultrashort Financials ETF (double short), and IYF is unleveraged long financials ETF. For BKX to go from May 22 level to March low of about $17, that's 50% correction. As a double short ETF, SKF should at least go up 100%.

I said "should", because, in real market, the index does not drop 50% in one day. So I created 4 case studies:

• BKX will drop 10% every trading day until it hits March low;
• BKX will drop to March low but go down in a zig zag;
• BKX will drop to March low but not before it goes back up to May high and touches 200-DMA;
• BKX will drop to March low but not before it almost retakes December high.

After observing the market action and BKX since then, I just added one more case, not a very good one for the market bears and SKF bulls:

• BKX will hold at this level, and go up in zig zag, taking out prior levels, all the way up to September-October 08 level.

Case study 1: BKX will drop 10% every trading day until it hits March low:

Case study 2: BKX will drop to March low but go down in a zig zag:

Case study 3: BKX will drop to March low but not before it goes back up to May high and touches 200-DMA:

Case study 4: BKX will drop to March low but not before it almost retakes December high:

Case study 5: BKX will hold at this level, and go up in zig zag, taking out prior levels, all the way up to September-October 08 level:

Last September, SKF was trading above $100.

Today, SKF is trading slightly below $40, with one hour of trading left. IYF is around $44. BKX is at 37.76.

I am totally out of leveraged short ETFs for now. I have a feeling that BKX could run back to December high (around $46). It is tempting to short SKF, or buy puts, with the target price of $25.

Unleveraged short ETF Does Not Perform, Either

SEF is Proshare Short Financials, an unleveraged short ETF. Having examined the performance of leveraged (2x, 3x) short and long ETFs, I thought, maybe an unleveraged short ETF would be the way to go when the market turns south again, because it was the leverage that exercebated the volatility decay.

Wrong again. Take a look at the chart below. It compares SEF and XLF (unleveraged Financial Sector SPDR ETF) for the same 6 months. The green line is at 0% change. XLF is back to the same level, an SEF is down almost 40%. If I connect the points where two lines intersect (the black line on the chart), the symmetry does exist on the either side of this declining line.

From the looks of it, even if XLF were to correct 50% from here, SEF would only go up to about November 08 level, at best.

Leveraged Long ETFs May Not Be What You Think, Either

Danger of leveraged short ETFs has been discussed in this post, but here's more. The focus is on financial LONG ETFs.

XLF is un-leveraged, UYG is double long, FAS is triple long. Looking at their charts, you wouldn't be able to tell that, would you? XLF is almost back to the December level, while UYG is about half that, and FAS is about 1/3.

UYG has more than doubled since March low, and FAS more than tripled while XLF is slightly less than doubled. So if you were able to pick that bottom, good for you, you have bagged the huge gain. On the other hand, if you have been holding XLF since the beginning of the year and didn't sell into the dump in March, you are back to where you started. The same cannot be said for UYG and FAS.

Here's another set of charts, comparing FAS (triple long) and FAZ (triple short). Visually, in the bigger scheme of things, they both seem to be flat-lining. There are enough daily fluctuations for trades, but I'm now more convinced that they are indeed for short-term trades only.

Pitfalls of Ultrashort ETFs

Boy have I learned that thoroughly! Take a look at these charts. They are Ultrashort ETFs that are supposed to replicate 200% inverse (double short) of the performance of the underlying indices. They have been quite popular among both retail investors and professional traders since the October/November Cascading Waterfall Crash of 2008, but some pundits (most vocal being Jim Cramer of Mad Money fame) are increasingly critical of this type of ETFs, blaming them for the terrible market we have had since October.

Below are the charts of the popular (and once popular) double short ETFs.
FXP: Ultrashort FTSE/Xinhua China 25 (high: $183.99, 5/8: $15.20)
EEV: Ultrashort Emerging Markets (high: $207.10, 5/8: $23.52)
SRS: Ultrashort Real Estate (high: $295.72, 5/8: $19.78)
SKF: Ultrashort Financial (high: $303.82, 5/8: $38.94)
SDS: Ultrashort S&P 500 (high: $133.20, 5/8: 56.03)
QID: Ultrashort QQQQ (high: $102.60, 5/8: $37.20)

and to compare that with the general market,
SPY: (long) S&P 500 (9/2: $127.99, 5/8: $92.98)
VIX: CBOE Volatility Index (9/2: 21.99, high: 80.86 (December), 5/8: 32.05)


Despite the market turmoil, the first to whimp out was FXP, as Shanghai Index bottomed in early November. Next in line was EEV, emerging markets double short. Then SRS, commercial real estate double short, even though CRE is every analyst's favorite "next shoe". SKF, financial double short, performed well enough until recently, then went from $250 to $39 in 8 weeks. SDS, double short of S&P 500 index, and QID, double short of Nasdaq, appear to be in better shape than their peers, but compare them to SPY. Despite the recent run, SPY is nowhere near the level of last September (it is down 27%). Yet, SDS and QID are barely hanging on to the unchanged level.

Why this happens is in the very method that these ultrashort ETFs are created. They are meant to follow the daily performance of the underlying indices. Keyword here is DAILY. For more on this, read here, and here.

If you didn't know this and held these ETFs as an investment, instead of profiting from the market turmoil you would end up with less money, far less. In order for these short ETFs to work, you need 1) high/increasing volatility; 2)for that volatility to sustain and go up further for some period. Even in such volatile period, if you are not quick enough, you end up losing all the nice fat gains. Take another look at the charts. See the huge spike in prices in October-November period? During that period, these short ETFs acted like OPTIONS. And I think that is what they are: options, without expiration date.


Here's one example of rather absurd outcome: SKF (blue line) vs IYF (red line, long financials ETF, no leverage). Since September last year, IYF has lost 43%. SKF has lost 63%.

The winning trade, therefore, was to short BOTH.

Double long, or triple long ETFs do not seem to decay as much, though they often "underperform" single ETFs.

So, the lessons learned for me with ultrashort ETFs and triple short ETFs are:
1. Use them only when we have a sustained period of down market. Or day trade. (You really can't beat the thrill of seeing FAZ (triple short financials) go up 25% in a few hours... Oh I talk like a gambling addict, don't I?)

2. It is better to short the long ETFs or underlying stocks, or buy puts (in case of IRA accounts) if you are going to hold short positions for a sustained period of time.

I have traded SDS, SKF (double shorts), SSO (double long), and FAZ (triple short). Miraculously in retrospect, I made money on all of them except SSO (which I got out about even) without quite understanding how these ultrashort ETF behave. Luckily for me, the market was in a severe, sustained downturn.

I still have FAZ, my third purchase, that I'm stuck with. At this point, the share price got so ridiculously low (FAZ went from recent high of $104.07 on March 6 to May 8's $4.49: mind-boggling 96% down in 2 months) I'm keeping it as an amusement to see how low it will go. It will probably go at least as low as FAS, its triple long counterpart, went: $2.64. All the loss on FAZ has been more than made up by hansome gains by FAS. If this rally continues, FAZ will go to ultrashort ETF money heaven. If the bears return in vengeance, my single-digit FAZ can go up 1000% in a few days...