Last July ProFunds released an interesting ETF product, called ProShares, which can provide double the inverse performance of some of the major indices. These are in addition to several other ProShares leveraged offerings:

There already exists a few open ended mutual funds from ProFunds and Rydex that do the same thing, but they come with expense ratios of around 1.5% compared to only 0.95% for the ProShares.

As a bear I was attracted to the double inverse ProShares since they can be held within retirement accounts. I would also be interested in holding them in my non-retirement accounts if they offered more leverage than shorting. Due to the margin requirements of my broker I am required to have 130% of the value of a short position of any option eligible securities. Buying ProShares, on the other hand, requires margin of 50%.

To use the UltraShort S&P 500 (AMEX:SDS) as an example, every $100 of margin in my account allows me to hold $200 of the SDS (or $200 of double the inverse of the S&P 500). If I were to short $200 of the S&P 500 in the traditional sense through the Standard & Poor’s Depository Recipts (AMEX:SPY), I would need only $60.

Now let’s say the S&P 500 declined by 10% after 1 year. Then my $200 holdings of SDS will gain by 20% or $40. Since I invested only $100 my return would be 40%. On the other hand, my $100 would allow me to short a maximum of $333.33 of SPY. Since the S&P 500 fell be 10% the SPY will fall by 10% too. Under this scenario I would gain $33.33 or 33.33%.

Of course leverage can work both ways: if instead the S&P 500 had increased by 10% I would have lost 40% through buying the SDS compared to only a 33.33% loss by shorting the SPY.

There are some other costs associated with holding the UltraShort ETF’s that were not factored in this analysis. First, buying with margin entails interest expenses on the loan amount. In my case, currently my broker charges 6% annually. Second, there is an expense ratio of 0.95% for all ProShares. And third, the funds employ swaps which can have negative tax consequences.

As good as these ETFs are, they are not superior to shorting or even futures which can offer much more leverage. These products are better suited for accounts that are unable to short like retirement accounts.

I currently own the SDS and the UltraShort MidCap 400 (AMEX:MZZ) in my retirement accounts.