Skip to main content

ProShares Ultra Short Financial ETF staggers and recovers

I recently wrote a post ("Who benefits from new short selling rules?") discussing the impact of the new rules that ban "naked" shorting. My position was that this would probably increase the trading volume in the ProShares ultra short ETFs.

Since then we have seen the imposition of yet another rule. In an attempt to protect financial stocks, the SEC has prohibited short sales of shares of certain financial companies. The list of protected financial companies has now expanded to over 900.

While many of the ProShares ultra short ETFs continued to trade in a manner that is decently tracking the action in the underlying index they are shorting, the Ultra Short Financial ETF (SKF) ran into huge problems.

After getting hammered on Thursday and Friday of last week, SKF barely opened on Monday. It was almost noon before it started trading in earnest. Remember, Monday was the day when the well-known Financial Select Sector SPDR ETF (XLF) fell over 8%. SKF should have jumped 16%. By the end of the day, though, SKF hadn't come anywhere near that gain.

What was going on? Did the shorting ban affect SKF?

ProShares does not actually short the market. Instead, they use multiple financial instruments, in an attempt to mimic the inverse performance of the underlying index. Per the prospectus, those instruments are:

  • Futures contracts and options on futures contracts
  • Swap agreements
  • Forward contracts
  • Options on securities and stock indexes and investments covering such positions
OK, that means they shouldn't be impacted by the shorting ban, right? Not so fast.

ProShares announced on Monday that "Short Financials ProShares (SEF) and UltraShort Financials ProShares (SKF) are not expected to accept orders from Authorized Participants to create shares until further notice". In other words, shares would not be created for those who wished to buy the ETF.

The problem seems to have been hidden a layer deeper than the ProShares ETF itself. As stated above, ProShares enters into swap agreements. This means we need to consider the actions of the counterparties to those swaps. With the government instituting a ban on shorting financials, what happens when the counterparties suddenly find themselves unable to short the market? Everything grinds to a halt.

That's what we saw on Monday. It seems that by Tuesday, they have sorted things out. There are numerous ways to institute a short position without actually breaking the no-shorting rule. It appears that ProShares may have shifted the mix of financial instruments they are using. It is also likely that their swap counterparties have also moved to what can be called "synthetic shorting" using a mix of options, for example. In any case, SKF did deliver about twice the inverse of the performance of XLF.

As one of the articles mentioned below says, the government's unpredictable actions are the ultimate counterparty risk. In the meantime, SKF seems to be soldiering on. Given the unfavorable reception the Paulson plan received in Congress today, SKF will hopefully continue to do its job delivering solid upside as the financial sector weakens again.

Related articles:

I highly recommend the following excellent articles if you wish to go into further detail:

Proshares and Rydex inverse funds supposedly unaffected

Proshares biggest counterparty risk is US Government

Ultra ETFs and Counterparty Risk

The Synthetic Version of Shorting

Disclosure: long SKF


Popular posts from this blog

Brazil - in a bubble or on a roll?

A couple of years ago, no one recognized the real estate bubble even though it was under everyone's nose. Now, analysts and bloggers are seeing bubbles everywhere they look. One of them, they say is in Brazil whose Bovespa stock market index has doubled in the last 12 months. Does the bubble accusation hold water? I don't think so and here are 7 reasons why Brazil is by no means a bubble economy: Exports have held up over the past year thanks to demand from China for Brazil's soya exports and iron ore. This was helped by the the Brazilian government's drive to improve trade links with Asia and Africa. Export diversification, spurred by a more active trade policy and increased focus on "south-south" trade under current president Lula, helped mitigate the decline in demand from OECD (Organization for Economic Co-operation and Development) countries A "sensible" economic framework has been in place since the 1990's. This has included inflation

Thursday Bounce: Trend Busters, Swing Signals and Trend Leaders for July 9, 2009

This is a quick post to announce that we have published Thursday's Trend Leaders, Swing Signals and Trend Busters at Alert HQ . All are based on daily data. Today we have the following: 72 Swing Signals -- A couple of days ago we had 35 signals, today we have twice as many. Happily, we now have 65 BUY signals, a mere 4 SELL Signals plus 3 Strong BUYs. Whoo-hoo! 56 Trend Leaders , all in strong up-trends according to Aroon, MACD and DMI. There are 18 new stocks that made today's list and 60 that fell off Tuesday's list. 48 Trend Busters of which 5 are BUY signals and 43 are SELL signals The view from Alert HQ -- Talk about mixed signals. If you look at our Swing Signals list you would think the market was in the middle of a big bounce. BUY signals are swamping the SELL signals and we even have a few Strong BUYs. Yes, there's a good sprinkling of tech stocks and tech ETFs but the distribution is pretty broad-based with a good number of different sectors represented, eve

Unlock Stock Market Profits - Key #1

This is the first in an ongoing series of articles where I discuss what I feel are keys to successful investing. It is based on a post that provides a summary of the ten keys that individual investors should use to identify profitable stock trades. ( Click here to read the original post ) There are two basic steps to investing. First, you need to find stocks that seem to have some potential. Then you have to determine whether these stocks are actually good investments. There are many stocks that at first glance look interesting, but further research reveals that there are too many negatives to warrant taking a position. This first post in the series starts at the beginning: getting good investment ideas. Key #1: If something special is happening to a stock, it will be reflected in some kind of unusual activity in the markets. As individual investors, we will never be the first to know; however, unusual activity can be an early sign that allows us to follow the Wall Street professional