Are you extremely bearish on the market? Some will tell you to rush and by SDS or BGZ, ETFs that track the double and triple the inverse reactin of the S&P 500 respectively.

That may be a good idea if your holding period is a couple of days, but it doesn’t work out well for long-term bets. Whether you are buying an ultra long or an ultra short, the mechanics of the leverage the ETF uses burns you long-term.

This is mainly due to the fact that the ETF doubles or triples the daily, not monthly or yearly index. Let’s see the effect of this. Suppose the S&P 500 makes the following moves over the course of 5 days (double move in paranthesis).

Day 1: +5% (+10%)

Day 2: -3% (-6%)

Day 3: +1% (+2%)

Day 4: -12% (-24%)

Day 5: +10% (+20%)

The standard S&P 500 would have moved -.4%, essentially unchanged. The math is 1.05*.97*1.01*.88*1.1.

The ultra’s math would be 1.1*.94*1.02*.76*1.2, resulting in a loss of 3.9%, well more than just double the loss of the S&P 500.

The ultra inverse’s math would be the flip of ultra long, so it would be .9*1.06*.98*1.24*.8, resulting in a loss of 7.3%. So even though the market went down a little, the ultra short managed to go down a lot! How did this happen?

It’s because of the mechanics of leverage and the fact that negative moves have more of an effect than positive moves. Think about it. If the S&P 500 goes down 50%, it then needs to double to just get back to even. The short ETF, even though it is betting against the market, still moves in the same way as the stock.

If you are bearish long-term, don’t buy SDS or BGZ and just hold. You can get burned during just a short market rally. If you’re a long-term bear, either short SSO or BGU (the ultra longs) or just short the SPY or individual stocks.