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One piece of good news for investors in the past year or so regards that vast proliferation of exchange traded funds. Of course, one of the worst pieces of news for investors has been that this growth has reached something of an “epidemic,” and with each passing day it becomes more and more difficult to keep up with all of the new entries into the “ETF world."

For years, both the Profunds and Rydex families of funds have offered a variety of index and sector funds, including long and short funds and some that use leverage. Still, the minimums for opening accounts at these families was relatively steep ($15K and $25K, respectively). In the most recent fortnight, however, both families have begun to offer many exchange-traded versions of many of their open-end funds. This development is at the same time a source of great opportunity as well as potential confusion. To get an idea of the myriad choices available, consider the ETFs listed in Table 1. These ETFs are offered under the ProShares banner, an offshoot of the Profunds family. The funds listed in Table 1 are all “index” funds. However, each is focused on a particular “slice” of the market. Some are “long” funds, others are “short” funds, and some use leverage of 2-to-1. Whatever the “flavor,” each of these funds can be bought and sold through a standard brokerage account just like any other stock. It is not necessary to open an account with Profunds in order to trade these ETFs.

Table 1 – ProShares Index Funds

Clearly there are a lot of opportunities to choose from in Table 1. And just as clearly a trader should do some serious thinking before buying any of these funds since the potential risk of say, buying a fund that is short two times the Nasdaq 100, is great. The bottom line is that these funds are designed for traders who are looking to maximize their profit potential and who understand and are willing to accept a greater degree of risk. Consider the action of the two ETFs that appear in Chart 1.

The ETF on the top is QLD, which fluctuates at a rate of two times the Nasdaq 100. In other words, if the Nasdaq 100 is up 1%, this fund will be up approximately 2%. On the bottom is QID, which fluctuates at a rate of inverse two times the Nasdaq 100. In other words, if the Nasdaq 100 is up 1%, QID should be down approximately -2%. Obviously, if Trader A buy QLD and Trader B buys QID there will eventually be a winner and a loser.

Chart 1 – Ultra Long and Ultra Short the Nasdaq 100

While no one has the ability to pick tops and bottoms with any consistency, for the sake of illustrating the potential available to a trader using these funds. Had a trader been prescient enough to get bullish on 8/16/07, bearish on 10/31/07 and bullish again on 3/10/08, he could have made the following trades:

• Between 8/16/07 and 10/31/07 QLD (long NDX * 2) rose +43.8%.
• Between 10/31/07 and 3/10/08 QID (short NDX * 2) rose +69.3%.
• Between 3/10/08 through 4/7/08 QLD (long NDX * 2) rose +22.0%.

So in theory, $1,000 invested as above could have grown to $2,972, or +197%, in about 8 months time. Now obviously a lot of money can be made if you always buy at the bottom and sell at the top, which of course, no one does. Nevertheless, this example does clearly illustrate the types of rewards available to successful traders.   

The trick, of course, is knowing when to switch from being long two times the Dow to being short two times the small-cap Russell 2000. Ah, there’s the rub. However, this week’s piece is not a “timing piece." The purpose this time around is simply to:

• Make you aware of some of the possibilities that exist.
• Help you to organize and/or categorize these various possibilities.
• Point out the potential benefits of finding a way to switch between these various funds.

In future articles I hope to point out other possibilities, including long and short leveraged sector funds and also long and short leveraged “style” funds (i.e., large-cap growth, small-cap value, etc.) as well as a few simple techniques for determining “when to be where."

To search for previous articles written by Jay Kaeppel, please click here.


Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site

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