DIG and DUG


Today, let’s talk Ultra ETFs.  These are the wonderful inventions trading on the AMEX with wonderous sounding names like Ultra Oil and Gas and Real Estate 3X.  These are “funds” that use options to cause the ETF’s value to move according to the movements of some index.  For example, a Retailer Short 2X would be designed to increase 20% if an index of retail stocks fell by 10%.  Likewise, the fund would fall by 20% if the same index increased 10%.  The trouble is these ETFs don’t always do what you would expect.  For example:

 Look at DIG and DUG.  DIG is supposed to go up when oil stocks do well; DUG is supposed to go up when they do poorly.  So you’d think you’d make money if oil stocks do well and you’ve bought DIG, right?  Let’s look at the one-day chart for DIG vs. DUG:

http://finance.yahoo.com/q/bc?s=DIG&t=1d&l=on&z=m&q=l&c=DUG

Note that DIG is a direct reflection of DUG, just as you would expect.  So let’s go all in, because with oil climbing, we could make a killing if we wait long enough, right?  Not so fast.  Take a look at the two-year chart:

http://finance.yahoo.com/q/bc?s=DIG&t=2y&l=on&z=m&q=l&c=DUG

Despite the recent rise in oil prices, DIG and DUG have both lost about half of their value since May 08! 

How is this possible?  The trouble is that the ETF’s only work for one day.  If an index goes up 10%, the Short ETF will go down 20% for that day.  But because it is reset each day, you get bizarre behaviour.  For example, if the index went up 10%, then down 10%, then up 10%, then down 10% over a period of 4 days, the INDEX would have gone from 100 to 110 on day 1, 110 to 99 on day 2, from 99 to 108 on day 3, and then finally from 108 to 97.2 on day 4, ending up with a loss of 2.8%.  If we’d bought the Ultra Short ETF, however, designed to double the behaviour of the index, it would have gone from 100 to 80 on day 1 (-20%), from 80 to 96 on day 2(+20%), from 96 to 76.8 on day 3 (-20%), and then from 76.8 to 92.2 on Day 4, for a loss of about 8% instead of a gain of 5.6% that you were expecting!

Stay away from these Ultra ETF’s, they’re bad news.

Refer a friend – link to this page: https://smallivy.wordpress.com

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security.  Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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