With the run that the stock market has had since last summer it’s natural to start worrying about a severe price correction. After all, many indices are back to the pre-crash levels of 2008 and the Russell 2000 is back to levels not seen since the fall of 2007. Therefore it seemed logical to talk about ways to profit from a correction or at least hedge some portfolio risk.

Over the years there have been many instruments developed that can be used to play both sides of the market or hedge portfolio risk. These include:

Stock Options
Stock index Futures and Options
Single Stock Futures and Options
Short and Leveraged Short ETFs

The leveraged short ETF is becoming one of my favorite ways to play the short side in stocks. I used to use options but there is so much time decay, especially on the short dated options that it’s sometimes hard to stay in the position as long as it’s needed. Therefore, I began looking at the leveraged short ETFs to see if they could provide some of the same benefits.

In this particular piece we are going to focus on the Short Russell 2000 ETFs. There are both the double (2x) and triple (3x) inverse ETFs to choose from.

The Double Short ETF is from ProShares and trades with the ticker symbol TWM. The goal of this fund it to provide a -200% correlation to the daily movement of the Russell 2000 Index. So if the Russell 2000 drops 1% on a given day, then TWM should rise 2%.

TWM is currently trading at $11.58 so even using a 20% stop I would only be risking about $230 on a 100 share position.

The Triple Short ETF is from Direxion and trades under the ticker symbol TZA. The goal of this fund is to provide a -300% correlation to the daily movement of the Russell 2000 Index. So a 1% drop on a given day in the R2K should cause a 3% pop in TZA.

TZA is currently trading at $13.70 so again a 20% stop would only be about $275.

You can see by the chart below that even small corrections in the Russell 2000 can cause significant jumps in TZA.

Small Corrections In The Russell 2000 Cause TZA To Jump
This chart is from 4/15/2010 to 9/9/2010 and is for illustrative purposes only.

Leveraged ETFs are designed for short term trading and not for long term investing. Please make sure you read the prospectus and understand the risks before you enter a position.