New Bear Market ETF Strategies

FactorShares recently introduced a new line of ETFs (exchange-traded funds) focused on spread trading.

A spread trade is simply getting positive exposure to one thing, while having negative exposure to something else. This is sometimes known as a long/short strategy. For investors looking to hedge their accounts, FactorShares can provide a potentially interesting solution.

FactorShares currently has five different “flavors”, all of which provide leveraged exposure:

2x Gold Bull/S&P 500 Bear (ticker: FSG)
2x Oil Bull/S&P 500 Bear (FOL)
2x Treasury Bond Bull/S&P 500 Bear (FSA)
2x S&P 500 Bull/US Dollar Bear (FSU)
2x S&P 500 Bull/Treasury Bond Bear (FSE)

Every one of these funds are leveraged on both sides of the trade. This means that a small position can go a long way within a trading account. In some regards, you have up to four times the daily potential volatility of a typical investments — 2x on movement of the long position plus 2x the movement of the short.

Let’s take a look at the first (and possibly the most interesting of the group – the 2x Gold Bull/S&P 500 Bear ETF (FSG).

A $10,000 investment in FSG would track the combined daily gains and losses of a $20,000 long position of gold and a $20,000 short position of the S&P 500. This is a fairly extreme level of leverage for an ETF. On the other hand, if you feel strong about a bear market for stocks and higher prices for gold, this ETF could be the ticket.

Last Friday was something of a “perfect storm” for holders of FSG.  The S&P 500 was down 2.5%.  Gold prices gained 3.0%.  Holders of FSG were leveraged on both sides of the trade and gained 11%.  Wow!

The big trade-off here is daily volatility.  Over the past three weeks, the average daily range of price fluctuation for FSG has been 7%, while it was closer to 2.5% for the S&P 500 index.

Between the end of June mid-August, FSG more than doubled in value. Subsequently, FSG lost 30% of its value in the four trading days following August 19th (when stocks were rebounding and gold was selling off).

The conclusion – these ETFs can be remarkably potent in the right environment, but the underlying volatility suggests that they should only be used in small doses.

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