Saturday, January 17, 2009

Does Anyone Know What Happens to a 2X or 3X ETF when it Drops Below Zero?

Many Exchange Traded Funds are designed to track double or triple the return of an index or the reverse of an index. So what happens if that ETF goes negative? Does your brokerage firm send you a bill? This warrants further research on my part, maybe for a more extensive article.

If you are looking for really low priced ETF's, here are a few that trade for less than $5. Shown is the recent price.

ELEMENTS CS Global Warming ETN (GWO) $4.92
ELEMENTS Rogers Intl Commodity Energy ETN (RJN) $4.84
Ultra Financials ProShares (UYG) $3.84
Internet Infrastructure HOLDRs (IIH) $1.77
B2B Internet HOLDRs (BHH) $0.24

Author does not own any of the above at the time this was written.


1 comment:

Brian said...

I've spoken to ProShares about this very issue. Here's the deal:

1) It would be really hard for any of these to actually go to zero (less hard with the 3x). For the Ultras (2x) you would have to see a 50% down day in the underlying index. So while an ultra etf might be at $10, a 40% loss puts it at 6, another 40% loss at $3.60, another 40% loss at $2.16, etc. The point is that unless there is a 100% loss there will always be some value remaining, no matter how small. Remember a 40% loss on $.01 would make the fund worth $.006 and so on and so forth.

2) The ProShares people told me if a fund ever did go to zero they would convene their investment board and likely liquidate the fund. Basically a total loss of your investment.