Volatility Remains High While UltraShort ETFs Pop

By Steve Patterson | November 24, 2008 AAA

Both the ProShares UltraShort Financials (NYSE:SKF) and the UltraShort Real Estate ProShares (NYSE:SRS) skyrocketed the week ending November 21 as volatility moved higher and investors looked for additional weakness in the real estate markets and the Financials.

Friday wasn't so kind as both closed down but over the five day period SKF was up 48% and SRS saw a 33.2% increase.

Fear the Fear Index
Volatility as measured by the CBOE Volatility Index remains near 75 for November, which is a record level. Sometimes referred to as the "Fear Index", the Volatility Index measures the number of option hedges in the market. When an investor purchases puts against a stock position for protection, this would be considered one common scenario of an option hedge. (To protect your assets, read Reducing Risk With Options.)

The index over the past year has remained in the 20-30 range but since a spike that began in September has vacillated between 50 and 80. This shows an increased amount of anxiety that stocks will continue to decline for the next three to four months. The highest level of the index since 1990 was 46 in October of 1998.

UltraShort Financials
The UltraShort Financials ProShares exchange-traded fund (ETF) spiked from a close of $188 per share on Tuesday to a high near $300 per share on Friday. This is a about a 58% run over a three day period. The ETF attempts to return double the inverse return of the Dow Jones Industrial US Financials index. This large move against U.S.-based financials is remarkable and would be even more amazing if a correction in the index does not occur within a week. (For more check out Inverse ETFs Can Lift A Falling Portfolio and Index Investing: The Dow Jones Industrial Average.)

Much of the financial weakness last week was a result of the Federal Reserve forecasting continued troubles in the economy. Charles Evans, president of the Federal Reserve Bank of Chicago, stated on Friday that the economy will not recover until 2010 or 2011, thus making all the recent attempts by the Federal Reserve to shore up the financial markets unsuccessful.

Uncertainty was also driven by a belief that Citigroup (NYSE:C) has made a number of poor decisions that will affect its profitability going forward. The stock was pushed below $4.00 on Friday. Citigroup fell by 57% during the week as the company reported problems with its commercial real estate portfolio and the need to absorb $17.4 billion in structured investment vehicles assets from a subsidiary after the government decided not to take on bad bank assets as a part of its bailout plan.

UltraShort Real Estate
The ProShares UltraShort Real Estate ETF also made a monster move during the final three days of the week, moving from a close of $177 per share on Tuesday to a high of $295.72 per share on Friday but ended up closing the week at $216.67. This fund attempts to return the double inverse of the Dow Jones Industrial US Real Estate index. Home construction was an issue in the real estate market as new building permit requests reached a low not seen in 50 years according to data put out by the Commerce Department Wednesday. (Read about why this is an important statistic for investors in Economic Indicators: Housing Starts.)

Real estate and financial ETFs saw a lot of buying interest as investors feared additional downward pressure on stocks to come. The Federal Reserve predicted more economic declines until at least 2010 while new home constructions reached a 50-year low. Both the SKF and SRS rallied near 50% to new 52-week highs before a drop in the last minutes of trading, and both might see further correction after such a large run-up.

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