The Big Money Goes Short

03/10/2008 12:00 am EST

Focus: MARKETS

Peter Way

Founder and CIO, Peter Way Associates

Peter Way, editor of Block Traders’ ETF Monitor, says professional investors have been making bearish bets in levered short ETFs. But don’t try this at home.

Are ETF investors pulling their money out to find a safer place than stock investments?

Not when you compare the market values of biggest and most active 250 or so ETFs that we cover to the principal market indexes. Those indexes are down -14% and -19% from their highs, while ETF investments are up 21.5% to over $505 billion, clearly due to the inflow of new capital since late October.

But the most interesting changes have come in the way ETFs are being used as tactical and strategic tools, both by individual investors and, more influentially, by professional investors.

[Recently over the course of two weeks] there have been $1.5 billion of new bets against the stock market’s rising. The total now bet is over $10 billion, and most of the big bets have been in levered short instruments, where the payoff for being bearish is about doubled.

These are instruments that investors can buy long, but they have been so constructed that when prices of the holdings of the fund go down, the price of the fund goes up. Their levered cousins in effect use the margin rules to accomplish a near-two-for-one price impact, but all within the initial structure of the ETF. There are also levered parallels on the long side, for when optimistic times return.

Back in the 20th century, being short a stock, or “the market” (if you could find a way) was in some circles considered “un-American.” Today it appears to be just another way to make money. If you’re right.

In fact, the million-dollar market-makers are reacting to client intentions in the ProShares Ultra Short Nasdaq 100 Index ETF  (Amex: QID) in ways that say it may be one of the best bets at present of all available ETF choices.

My guess is that the market pros have a pretty good focus on the picture. But make no mistake, this is a game of pro vs. pro, and things can change very quickly. Only pretty well-informed and savvy professional investors are likely to be alert to the kind of opportunity potentials present here, and the instruments available to exploit them. If you are looking for thrills and spills, here you are, but stay alert.

Another sidelight: Some investors think China investing may have gotten overdone. The principal ETF vehicle here has been the iShares FTSE/Xinhua China 25 Index (NYSEArca: FXI) of 25 leading companies. In response, the ETF community brought forth the UltraShort FTSE/Xinhua China 25 ProShares (Amex: FXP), a levered short version of the FXI. It has performed about inversely to the FXI.

Being able to take lower-risk (or at least lower-concern) positions that are contra to usual long investment positions provides useful balance to the markets. In this case $769 million of investment has been attracted (and value created) by the FXP in three months since November.

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