I’ve received some emails regarding my recent post Ultra ETFs and Counterparty Risk. People are interested and amazed to learn there are ways to make money as the stock market drops. It used to be that one needed to short stocks directly or buy put calls in order to profit from a declining stock market. Now there are two methods that are hands-off.

Method one is the buying of leveraged inverse ETFs. ProShares, ProFunds, Rydex, and Direxion offer these investments. I’ve read the prospectus for all these companies and they are all exposed to counterparty risk. These are new investment vehicles and have never been battle-tested in a credit crisis situation. Although the risk is probably small, there is simply no way to know. What happens if the counterparty underlying your leveraged ETF gets in trouble like Bear Stearns? There could be a mad rush to sell regardless of how the investment itself is performing.

Method two is buying into a mutual fund that does direct shorting. I’ve read the prospectus for Prudent Bear (BEARX) and Grizzly Short (GRZZX). There is no mention of counterparty risk. There is a third bear market fund called Comstock Capital Value Fund. Comstock has a hideous looking web site and lists the <title> of their page as Untitled. I wouldn’t buy a T-shirt from a company with a web site that unprofessional, let alone give them my money to manage.

Due to the unknown counterparty risk, I’m transitioning my bear market exposure from Method one to Method two.