Cramer on shorting

[Nepenthe]

Originally Posted by brokerdave

can you guys explain this process a little more to me? when cramer was talking about this the other day i was thinking, wtf is he talking about. i understand options/puts and his point on how it is not helping the situation, but the 2X, 3X i have no idea what it stands for or the ETF's. is this something i can do on scottrade?

if you can even just point me to a source that i can read up on. i would be interested to learn.

thanks for any help.

dave

Sure Dave.

ETF = exchange-traded fund. You've no doubt heard of Index funds, like the $100 Billion Vanguard S&P 500. An exchange-traded fund in its basic form works very much like an index fund, but instead of trading at the end of the day only, like a mutual fund, it trades all day long, every second (depending on volume). So an ETF tracks the index throughout the day. You can buy and sell at any point (trading rules permitting).

ETFs have some real advantages. They've become very popular over the past few years. In fact, their popularity is exploding. SPY, also known as SPDR or Spider, which tracks the S&P 500, is the most actively traded share in the world. It traded NEARLY a BILLION shares on October 10th (over $75 Billion traded hands through SPY). Today was a moderate day with 444,000,000 shares traded. You can add GE, GM, AAPL, and MSFT shares traded together, and they still only come to about half of SPY's volume. There are many hundreds of ETFs though, and some have more limited volume -- a few tens of thousands per day or so.

Anyway, ETFs have really taken off, and companies that offer them have come up with creative ways to use them. There are commodity ETFs (gold, oil, materials, gas prices, etc.), currency ETFs (dollar, yen, euro, etc.), and ETFs available for dozens or hundreds of different indexes. Then they got really creative and started offering INVERSE ETFs (otherwise known as "short" ETFs). An inverse ETF tries to approximate the OPPOSITE of its underlying index, so if the index is down 2%, it will be UP 2% for that day.

Then they got even more creative and started offering LEVERAGED ETFs (and combining leverage with inverse). A leveraged ETF tries to to approximate double (2X) or even triple (3X) the movement of its index, so if the index is down 2%, a 2X is down 4% and a -2X is up 4% (note that the leveraged ETFs do not hold up well over the long term, unlike normal 1X ETFs: Tracking Trouble for the Triple-Levered ETFs - Seeking Alpha ).

So a good example of these ETFs would be the aptly-named DIG and DUG. They both follow the Dow Jones US Oil and Gas Index. DIG is bullish/long/direct, DUG is bearish/short/inverse. So I would (in the past) buy DIG at open, hold it till noon, then sell it and buy DUG. The market looked roughly like an eroded pyramid, while if you graphed my intraday investment it would just look like a rough line climbing the whole time. Feels nice.

Note that using leverage is RISKY. However, what's really crazy is you can buy leveraged ETFs using margin (I wouldn't). There have been some days when certain 3X ETFs moved 35%! And the options market for these is absolutely insane. I've seen some up 1200% in one day (not for something I bought, just looking back at the day).

Links:

Exchange-traded fund - Wikipedia
ETF Center - SeekingAlpha
ETF Trends
Complete List of Currency ETFs
Complete List of Commodity ETFs

Currently I'm long calls on GLD, a gold spot price commodity ETF, and FXB, a british pound currency ETF. As you can see from the links, there are hundreds of ETFs out there and new ones all the time. Here's an example, new leveraged and inverse commodity ETFs: ProShares Launches First Leveraged and Short Commodity ETFs - Seeking Alpha

And yes, provided you have a normal brokerage account there should be nothing restricting you from purchasing these with Scottrade. Hope that helps.

[Nepenthe]

Don't forget about leveraged inverse mutual funds though: DXQSX: Basic Chart for DIREXION FDS NASDAQ 100 BEAR 2 - Yahoo! Finance

Year to date return 82% as of right now for that mutual fund. Trades like a normal fund -- end of day NAV, fractional shares, etc.

[brokerdave]

Originally Posted by Nepenthe

Don't forget about leveraged inverse mutual funds though: DXQSX: Basic Chart for DIREXION FDS NASDAQ 100 BEAR 2 - Yahoo! Finance

Year to date return 82% as of right now for that mutual fund. Trades like a normal fund -- end of day NAV, fractional shares, etc.

how does this one work then? it has its own funds manager that buys and sells in the ETF's?

when you mentioned the dig and dug, can these be used as long-term investments? the way i understand them is that they are leveraged margins built into a stock, but can you win/lose the same way? Are they strictly a daily short-term?

[Nepenthe]

Originally Posted by brokerdave

how does this one work then? it has its own funds manager that buys and sells in the ETF's?

It uses leverage, short selling, swaps, and options contracts to make its own trades. It doesn't have anything to do with the ETFs itself, it's just similar to the inverse ones but in mutual fund form.

Originally Posted by brokerdave

when you mentioned the dig and dug, can these be used as long-term investments? the way i understand them is that they are leveraged margins built into a stock, but can you win/lose the same way? Are they strictly a daily short-term?

You can hold ETFs for any length of time -- ten years or ten seconds. However, leveraged ETFs are a very bad long-term play. I would be very careful holding these for more than a few days (see the link from my previous post).

But other than that, you buy and sell ETFs and leveraged ETFs just the same as any stock. You don't need to have margin, you just purchase a round number of shares. You can place any type of order -- market, limit, stop loss or limit, trailing stops, contingent orders, one cancels the other collars, etc.

[goodbyehollywood]

The controversy seems to stem from a shift in strategy. Traditionally, bear market funds have been purchased as insurance against losses in an investor's core portfolio, as opposed to using them to "game" the market for maximum profit in downturns. Now, people are just trying to make money any way they can, and leveraged ultra shorts are high stake plays that can lead to big gains or big losses and, yes, big volatility. That's Cramer's biggest beef, though I think we'd be seeing that anyway, with all this manipulation and intervention. I don't have the experience to play them the way Nepenthe is doing-- quite successfully!-- so I stick to ETFs that let me be nimble with entry and exit points. Mutual funds (Direxion, Rydex or ProFunds) limit you when the market turns on a dime.

I'd be careful with the leveraged bear market funds, unless you have a high tolerance for volatility and risk. I'm long gold and Berkshire, trade several ultra shorts and am looking for reasonable exit points on a handful of dog stocks that I didn't get out of quickly enough. I also opportunistically trade story stocks, like GM and C, that I can get in and out of in a day, But, mostly, I'm in cash, because these are risky times and my risk tolerance isn't as high as it used to be.