Submitted by Gold Stock Prophet Blog

As I have mentioned before on this site, Horizon ETFs are a type of investment that allow traders to go long or short a particular market with 200% daily exposure. For example, this organization has two ETFs that track natural gas:

HNU-which stands for Horizon Natural gas Up
HND-which stands for Horizon Natural gas Down

This means that if in a given day, the price of natural gas rises by, say, 2%, then HNU should rise by about 4%, and HND should fall by about 4%.

Both of these ETFs were launched in mid-January 2008, with a price of $20.00 per share. What I was curious in finding out is what if you had purchased both of these ETF right from the start and held them to today. At first I thought that purchasing equal amounts of both ETFs would create a perfect hedge, with the gain of one fund offsetting the other. However, this was not the case.

Below is a chart showing HNU on the top panel, and HND on the bottom panel going back until the date these funds were launched:

If you click on the above image and read the annotations, you will see that if you had invested $10,000 into each fund on inception date, you would actually have produced a nice profit. The two funds, in other words, did not cancel each other out.

The reason for this is that as the price of natural gas rose, the balance of HNU was growing larger, and the balance of HND was becoming smaller. As this trend continued, the percentage change had a larger dollar value to work on with HNU and a smaller balance to work on with HND.

Put another way, the bull ETF has unlimited compounding potential upwards, but the bear ETF cannot reach zero, and its chart becomes what is know as asymptotic as it approaches the X axis of the chart.

Believe it or not, knowing this can be useful in the real world. Let’s say you have $10,000 worth of energy stocks in your portfolio, and you feel that perhaps now you want to take out some insurance against a potential market correction. To do this you would buy $5,000 worth of HED, which will rise 2% for every 1% the Canadian energy sector falls.

At this moment your $10,000 position is hedged. But if energy stocks continue to rise, your insurance in HED will start eroding, which will mean that to remain hedged you will need to buy increasing amounts of HED to maintain the hedge. Conversely, if a correction in energy does in fact materialize, then you would become over hedged if you do not trim back your exposure to HED as the correction continues.

I still think these ETFs are an innovative product, and, luckily, a new set of these type of ETFs have just been released:

•S&P 500 Bull Plus ETF
•S&P 500 Bear Plus ETF
•NASDAQ-100 Bull Plus ETF
•NASDAQ-100 Bear Plus ETF
•MSCI Emerging Markets Bull Plus ETF
•MSCI Emerging Markets Bear Plus ETF
•U.S. Dollar Bull Plus ETF
•U.S. Dollar Bear Plus ETF
•U.S. 30-year Bond Bull Plus ETF
•U.S. 30-year Bond Bear Plus ETF