Ultra ETF's
Investment Research for Online Traders

by John Dalt

You are probably familiar with ETF's (Exchange Traded Funds).  ETF's can track a basket of stocks, financial instruments, or commodities.  You can buy ETF's to track different sectors of the stock market such as tech, consumer goods, energy, financials, etc.  This gives the investor the security of avoiding exposure to one stock blowing up on them.  The last two years have seen an explosion in 'ULTRA' ETF's.  These ETF's track the target sector and seek to double the movement of the underlying financial instrument, on a daily basis.  There are also 'Inverse' ETF's that seek to move in the opposite direction of the underlying assets.  There are 'Double Inverse' and recently there are 'Triple' ETF's.

Part of using these ‘Ultra’ ETF's or ‘Doubles’ as some call them is understanding that they do not follow the cash market exactly. Just because oil goes up 10% does not mean the ETF will go up 20%. These ETF's are priced off the first month’s futures contract, not the cash spot market. This is important to keep in mind with all "Ultra, Double, Triple, or Inverse" ETF's, as none follow the cash market exactly. They are priced with futures or options, calls and shorts; they are correlated, but not exactly.

I have been disappointed when one falls twice as fast as the index it tracks, but climbs back at 1.6 times the gain! It is somewhat frustrating, but it would take an MIT PhD in mathematics to understand and predict. I have never had one fall at 1.6 times but recover at two times, go figure.  Recently, for example, spot Crude was up 6.4%, USO was up 7.69%, and DXO was up 12.55%.  Do not use ETFs that trade options or futures for long-term trades. These are dangerous except for short-term trades. They exhibit “tracking error” over time. The price of the ETF does not correlate to the cash price of the stocks or commodity it is following, because the futures or options determine its price.

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