Back in March, I wrote one of the most popular posts on this site titled Ultra ETFs and Counterparty Risk. It is a long detailed post where I outlined my concern that if a seismic shock to the financial world hit, I wouldn’t be completely confident that leveraged ETFs would survive.
Today AIG was bailed out. Karl Denninger sent out an alarm last night on how this move basically put a target on all firms that have exposure to CDS risk. He predicted that hedge funds could short these firms into default.
What happened today?
- Morgan Stanley was down 24%.
- Goldman Sachs was down 14%.
- The Russian market dropped so much they closed it.
- Gold set a one day record.
- T-Bill rates dropped to 1950s levels.
- S&P 500 dropped 4.7%. NASDAQ was down 4.9%.
Meanwhile our lawmakers and Presidential candidates are clueless to what is going on. They were warned. They failed to take action and now world financial markets are getting rocked. Is this the seismic shock? I don’t know, but I do know that I don’t want any counterparty exposure at this moment. I hate to be right about the direction of the market (down) and be wiped out because I was right. That would really suck.
Today I closed out my last two positions in UltraShort ETFs. Although I’m about 95% confident they will survive, that isn’t enough. I still believe the market will drop further, so I’ll be adding to my positions in the Prudent Bear and the Grizzly Short funds.
If the leveraged ETFs survive this financial crisis, I hope to use them again. But for now, my counterparty is over.
Jim
Sep 22, 2008 — 10:56 pm
Can’t remember if this was previously mentioned here, but you do know you can short double longs and remove counter party risk right?
Since you borrow the ETF when you short, you actually hold it. If the counter party blows up I assume the ETF will be worth even less than it otherwise would.
Gotta pay a dividend, but it is generally very small.
MAS
Sep 23, 2008 — 6:13 am
Yes, but my 401K account is not setup to trade options. For me it is easier just to use the managed bear mutual funds. Prudent was up 3% and Grizzly was up 7% yesterday.