Beware Of UltraShort ETFs - Caveat Investor
So let’s say a year ago you had the bright idea that oil prices were bound to fall, and you wanted to put your money where your mouth was. Being a retail investor with limited access or inclination towards complex strategies, you parked your money in the UltraShort Oil & Gas ETF (DUG) which, “seeks daily investment results, before fees and expenses, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Dow Jones U.S. Oil & Gas Index.”
How’d you do, smart guy? Not too well, as it turns out. Unless you got out during a short period in October when the index took a big spike, you’re actually down 26.72% over the last year.
Leveraged ETFs’ efficiency goes down with volatility. The problem is even more so with inverse ETFs. Let us say the Dow went from 10K to 8K and back to 10K. An inverse ETF tracking accurately will go up from 100 to 120 (20% gain to equal 20% loss in Dow) and then from 120 to 90 (25% loss because Dow gained 25%). So, from period t1 to t2, the Dow stayed the same, while its inverse ETF fell by 10% from 100 to 90. Repeat the same process x number of times, and you will find the inverse ETFs totally wiped out of the value, while underlying has not moved much. If the Dow goes up to 10000 from 9900 and back to 10000, the inverse would be reasonably accurate. However, we are at a historically high volatility - the highest in the last 20 years.
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