Trader’s Narrative

China’s stock market ignored all that talk in the summer about a bubble and continued to climb higher. Even a stamp tax increase imposed at the beginning of June this year didn’t impede its meteoric rise:

Usually the increase in transaction costs have been an effective way for the Chinese government to control rampant speculation in their stock exchange. See a history of previous stamp tax increases and their effect on the Shanghai market.

By reaching 6000 in mid October, the index has now multiplied itself 6 times (off its low in 2005). Yet that is still not as impressive as its last bull market in the early 90’s.

If you’re still holding on to the bearish thesis on China you have a new vehicle with which to short China: the UltraShort FTSE/Xinhua China 25 ProShare (FXP). This new ETF provides you with twice the inverse of the Chinese market. But keep in mind that that is merely its goal. It also comes with a hefty 0.95% MER. And remember, you’re going long to establish a short position!

As well, the UltraShort FTSE/Xinhua China 25 ProShare (FXP) isn’t really exposing you to actual Chinese shares. The only way I know that you can get real Chinese equity exposure through North American exchanges is through Morgan Stanley’s China A-Share Fund (CAF).

A reader (Pat) got in touch with me today to point out that there was something rather peculiar in the trading volumes of UltraShort S&P 500 ProShares (SDS) and the Ultra S&P 500 ProShares (SSO). If you’re not familiar with them, these are relatively new ETFs.

According to their prospecti, SDS and SSO seek daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of the S&P 500 Index.

As the name suggest, the UltraShort (SDS) ETF offers twice the inverse of the S&P 500. So when the S&P 500 goes up, it will go down twice the amount. While the Ultra (SSO) provides a leveraged bet (twice) on the index going the same way.

Although easy to ignore, since these are usually used as trading vehicles not investment vehicles, the expenses are surprisingly high at 0.95%. To compare, the SPDR S&P 500 ETF (SPY) only charges an MER of 0.0945%, or less than a tenth.

In any case, the level of activity in both ETF was very low until just at the end of February 2007, when we had the infamous Chinese mini-crash. After that, both ETF volumes perked up. But the UltraShort S&P 500 ProShares (SDS) volume increased much more. So Pat was wondering if this meant something in terms of sentiment.

Why is the trading volume of SDS (short ETF) almost 10 times more than SSO (long ETF)?

I really don’t know, but if I had to take a guess, I would say that people got really spooked when the market fell earlier this year. And maybe they suddenly discovered this new way to have exposure to the short side.

Many traders and investors who have cash accounts are not able to have short positions. But with this ETF, by going long (buying) they are in fact exposed to the short side. Almost makes your head hurt to think about it

I don’t think we can muster any sort of sentiment significance for this lopsided volume though. I consulted with a much wiser technical analyst (Jason Goepfert of Sentimentrader.com) and he agrees. He further added that instead of looking at the volume, track the assets that are in each ETF.

That way, you can get a glimpse into whether people are piling into the long or short side. And use that as a contrarian signal. This is similar, by the way, to how the Rydex Funds have been used for many years. The difference being that they are mutual funds and not ETFs.