ETF Talk: Shorting the S&P 500 Offers Risks and Rewards

The S&P 500 reached its highest value of the year by hitting $1,418.13 on Aug. 20. Despite the climb, economic uncertainty that includes continuing high unemployment and a looming “fiscal cliff” for the debt-plagued U.S. government could drive the index down in the coming weeks and months. If you think that the S&P 500’s best days of the year could be behind us, the ProShares UltraShort S&P 500 (SDS) is an exchange-traded fund (ETF) that you may want to consider. That fund is designed to increase twice the amount that the S&P 500 falls.

Another factor to weigh is the upcoming U.S. presidential election this November. If investors become worried about a given candidate winning and pursuing fiscally reckless policies, a short position could benefit you significantly. To the contrary, if a presidential candidate who will accept the responsibility of curbing runaway federal spending and trying to balance the U.S. fiscal budget advances toward election, the markets could rise and send SDS falling.

In addition, September traditionally is a precarious month for stocks. So, be wary about going short. If the market tanks, you profit. But if the market rebounds, you lose twice as much as investors going long will gain.

With the S&P 500 going up, SDS is down significantly from the beginning of the year. After opening at $18.70 in the beginning of January, SDS fell steadily throughout the year as the S&P 500 rose. The fund reached its lowest point of the year on Aug. 17, hitting $14.19, before closing at $14.36 on Aug. 28.

The ProShares UltraShort S&P 500 (SDS) is an established short fund that was created in July 2006. The ETF seeks a return that is twice the move of an index or other benchmark for a single day, as measured from one net asset value (NAV) calculation to the next. As of June 30, SDS’s top five index companies were Apple Inc. (AAPL), 4.44%; Exxon Mobil Corp. (XOM) 3.25%; Microsoft Corp. (MSFT), 1.86%; International Business Machines Corp (IBM), 1.83%, and General Electric Co. (GE), 1.79%. The fund’s top sector weightings, also on June 30, were Consumer (21.99%), Technology (15.20%), Financial (14.82%) and Energy (10.87%).

The good news for prospective investors of this fund is that it remains relatively cheap and continues to trade at a significant discount to its NAV of $28.55. SDS is a strong contrarian play and offers a hedge against the risk of a market decline. This fund would provide an extremely smart investment if the market plunges.

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