ProShares PSQ - Get shorty on the Nasdaq

I found a cool article over at Market Trends Before The Tape today about Exchange Traded Funds (ETFs) that track the performance of shorting the major indexes. In case you aren’t familiar with shorting stock, but the quick explanation is that shorting stock means to borrow it from an existing shareholder, sell it immediately in the market at the current price, and buy it back in the future to give the stock back to the person you borrowed it from. The idea being that you think the stock is going to decline and you want to sell it at the current levels and buy back at a lower level in the future. Basically, sell high and buy low… There is a more detailed description of the process here.

Anyway, the issue with shorting stock is that it exposes you to unlimited losses if the stock goes up. Lets say you believe Microsoft (MSFT) stock is highly overvalued at $30 a share. You can “short” lets say 100 shares of it, meaning you borrow 100 shares from someone who already owns it, and sell those 100 shares for $3000 ($30/share * 100 shares). If the stock subsequently drops to $25/share, you buy 100 shares of it for $2500 ($25/share * 100 shares) and give it back to the person you borrowed the initial 100 shares from. You’ve made $500 on the transaction, thats great, but what happens if the stock goes up?

You borrowed 100 shares and sold them for $3000. Lets say Microsoft announces some incredible news and the stock shoots to $50/share. Now you have to “cover” your position by buying 100 shares at $50/share which costs you $5000. You lost $2000 on the deal. Whereas a “long” position (a normal stock purchase) limits your loss at 100% of your investment, a short position potentially leaves you open to unlimited losses. Its a risky endeavor, you need to watch your positions carefully.

While shorting stocks is risky due to the unlimited loss potential, there is a reason to do it in some situations. Lets say you start to see the signs of a major downturn in technology or, more broadly, the whole NASDAQ. You certainly don’t want to have any long positions in the index as you think its going to decline. Being confident that it will decline soon, can you make money off the decline? Certainly! You can short the index. You could do it by shorting individual stocks that lead the index (think Cisco, Microsoft, Google, Intel, etc) or by shorting the index itself through an ETF. The issue is that you still leave yourself open to unlimited losses and, well, nobody wants that. Is there another way?

Yes, there is now. The explosion of ETF funds has created electronically traded funds that track everything. You can buy one “stock” now (its actually an ETF) that tracks the semiconductor index or the auto manufacturers or the market as a whole. PowerShares has created an ETF called “Short QQQ ProShares” (symbol: PSQ) that tracks the equivalent of shorting the Nasdaq. I haven’t been able to read all the details of how it works under the hood, but the basic idea is that you don’t have to borrow anything, you have no future obligation to purchase back the stock. This limits your losses to 100% of your investment, much like a long stock position. More importantly, its extremely easy to trade as you can buy it from your broker just like a regular stock using the symbol PSQ. It looks deadly accurate, see this chart from Yahoo! Finance showing its performance against the Nasdaq index. Its nearly a mirror image, indicating that as the Nasdaq goes down, PSQ goes up and vice versa. Its an excellent tool for speculation (if you think the market will tank) or hedging (if you want to have a position to protect against devastation to your portfolio if the market declines). Symbol “SH” does the exact same thing for the S&P 500 index. Its very interesting.

Chart showing relationship between PSQ and the Nasdaq: