First, understand my point of view. I have self-directed investments, but do not desire to allow trading to take over my life. I am not of the speculative mindset and do not try for lopsided killings. I would prefer to pick good stocks and buy and hold, but a bear market makes that a less-than-optimal strategy. Enter the leveraged inverse ETF as a hedging tool, doing the thing it was designed to do.

Once intellectually in command of the leveraged inverse ETF, I have new freedom. In a down market I am still free to assemble my portfolio of equities and conventional ETFs and hold it, rebalancing as my views of the long term gradually change. I can keep my shares and collect dividends. On up days I do not have to own any shares of my favorite leveraged inverse ETF. My thought is that I am always looking for a good reason to get rid of those shares, so I unload them as soon as things start looking bullish. Good days take care of themselves.

On a down day, one that I had a strong sense in advance was going to be a down day, I can load up on leveraged inverse ETFs and do better than just avoiding losses. Those days are pretty rare, but they do occur.

More frequently, in choppy trading, when the market dynamic is obscure, even baffling, buying into a leveraged inverse ETF can neutralize change in the value of my portfolio. I can just decline to make wagers. I can have no large gains or losses for the entire confusing, inscrutable day. If, on a particular day, I’m tired, or sick, too occupied with my day job or playing with the grandchildren, I can just set the market down, with fair safety, by neutrally hedging my portfolio first thing in the morning and selling out my position in an inverse leveraged ETF at 3:59 PM.

Case in point. Today, I couldn’t understand the market. Asia and Europe were down, but good news came from Michigan (consumer confidence), Chicago (purchasing managers) and Washington (personal income). So, things were unclear. Looked like it might go up, but ended up going down. I hedged out of the whole mess using ProShares SDS, and got some work done. Had I done nothing, I know I would have lost about 2.50%, because my portfolio tracks the S&P. As it stands I lost 0.08%, a very small amount. I sold every share of SDS at the end of the session. Monday might as well be years away.

I think leveraged inverse ETFs can reduce risk, ulcers and the amount of time you have to spend babysitting your portfolio, assuming that is not the thing you most love to do.

I suspect, even in the real world, that it in fact is an appropriate instrument for certain reasonable investors, and that any fault to be found with it is that there are people buying it without understanding it. (More so than with most instruments, I mean.) I expect that, even in those cases, the risk profile isn’t egregiously different from what they’re pursuing; there may be an insurance product layered on that they don’t realize they’re paying for, but it’s reasonably priced. This is nowhere near as bad as the rolling futures gold ETF that has been discussed here before, which genuinely is a bad instrument for long-term holding for anyone in any circumstances.

On the point of decay – even though these instruments decay over time, over a short term period (say, a week) the decay is often negligible unless there are some truly massive moves. So I’m not sure if I agree that they should never be held for anything more than a single trading day, which is your argument Felix. A whole month, perhaps, but to say that they’re toxic beyond the trading day seems to me to be quite exaggerated.

“Ultimately, the question we must ask ourselves is whether we want regulators to protect us from predatory and unethical behavior from issuers, brokers, and other Wall Street interests seeking to profit from illegal asymmetric information, or do we want them to protect us from our own laziness, naivete, and ineptitude.” – The Analyst

You should write a post on THAT topic, as it a foundational question for a lot of what you write.
Opinions on that point differ, and probably closely align with one’s larger political and economic worldview.

Herb Greenberg has also, on more than one occasion, demonstrated misconceptions about the simplest of ETF mechanics (creations/redemptions, rebalancing, etc). Herb is a smart guy who has been around markets forever – does that mean that no ETFs should exist since even Herb can’t understand them?

Felix, I think there’s two different arguments here: 1) whose fault is it that people do ignorant/lazy/stupid/greedy things? that’s kinda what I’m addressing. 2) The question you now seem to be asking is: “Why should these products exist in the first place?”

well, that’s a different question, which is why I haven’t answered it! I am generally not against giving grown adults the freedom to trade products that do EXACTLY what they aim to do – and which are clearly explained in the documentation – which is what these leveraged ETFs do. That’s the first and foremost important thing: these products do what they are supposed to do. If they didn’t, your argument would be an easy one.

Now – could you short $200k TLT instead of buying $100k TBT? Maybe – some people can – not everyone can. You are arguing (I think) that this additional “freedom” we are giving to investors is doing more harm than good. That may in fact be true, but it gets back to the question I was arguing – just because it does Y dollars of “bad” for the people who neglect to read the easily available information telling them what the product does, and only X dollars of “good” for traders who use the product correctly (and you’re assuming that X is less than Y) doesn’t mean that the product should be banned – in my world… In fact, much of “Capitalism” is like that. To put it harshly and simply, I don’t believe that people should be over-protected from their own stupidity.

just to repeat – the important points: no one is being coerced – no one is being misled (Except by Dave Kansas’s original, now corrected, article), no one is having the truth buried in impossible-to-read legal documents. The facts are right out there in the open, in bold face and italics, for anyone who so desires to read them.

http://www.proshares.com/funds/tbt.html

http://www.proshares.com/funds/performan ce/the_universal_effects_of_compounding. html