What is SSO? (Pros, Cons, and Strategies)

When considering investments that can potentially amplify your returns over the short to medium term, leveraged ETFs often come into play. Among these, ProShares Ultra S&P 500 (SSO) stands out, offering investors a way to double the exposure to the S&P 500 Index. But like any investment vehicle, it comes with its own set of pros and cons. So, let's delve into what SSO is, and discuss its benefits, drawbacks, and key strategies for investing.

What is SSO?

SSO is a leveraged ETF managed by ProShares, designed to provide twice (2x) the daily performance of the S&P 500 Index. Leveraged ETFs like SSO use financial derivatives and debt to amplify the returns of an underlying index, in this case, the S&P 500, which tracks 500 of the largest publicly traded companies in the U.S.

Key Features of SSO

• Targeted Performance: Aims to achieve daily investment returns, before fees and expenses, that correspond to two times (200%) the daily performance of the S&P 500.
• Holds Derivatives: Utilizes financial instruments such as futures contracts, swaps, and options.
• Short-Term Focus: Due to the daily reset feature, SSO is intended for sophisticated investors who understand the risks of leverage and are focused on short-term investments.

SSO Composition

SSO comprises components of the S&P 500 through derivatives. It doesn’t hold the actual stocks of the companies but rather engages in contracts that seek to replicate the performance of the index. Financial instruments are recalibrated daily to maintain the 2x leverage.

Pros of SSO

Potential for Enhanced Gains

The primary attraction of SSO is its potential to deliver double the returns of the S&P 500. For example, if the S&P 500 rises by 1% in a day, the ETF aims to achieve a 2% gain. This leverage can significantly enhance profits during bullish market conditions.

Liquidity

SSO is highly liquid, making it relatively easy for investors to buy and sell shares without substantially impacting the price. This liquidity is beneficial for traders who may need to move in and out of positions swiftly.

No Need for Margin Accounts

Unlike buying on margin with individual stocks, trading a leveraged ETF like SSO does not require a margin account. This makes it accessible to a broader range of investors who seek leveraged exposure without the complexities associated with margin trading.

Cons of SSO

Compounding Risk

One of the key disadvantages is the risk associated with daily compounding. The daily reset feature can lead to significant deviations from the expected performance over longer periods, especially in highly volatile markets. This could result in substantial losses, even if the S&P 500 is up over the same period.

High Expense Ratio

Leveraged ETFs, including SSO, typically come with higher expense ratios compared to non-leveraged ETFs. The cost of maintaining leverage eats into returns over time. SSO's expense ratio is higher than that of traditional ETFs but is justified by the nature of its investment strategy.

Unsuitable for Long-Term Investors

SSO is generally not recommended for long-term buy-and-hold strategies due to its daily reset feature. Investors looking for long-term exposure to the S&P 500 may be better served by non-leveraged ETFs, such as SPY or VOO, which track the index without multiplication.

SSO Investment Strategies

Despite its drawbacks, SSO can be a powerful tool when used appropriately. Here are some strategies to consider:

Short-Term Trading Strategy

Given SSO's daily reset mechanism, it is well-suited for short-term trading. Investors might use it to capitalize on short-term market movements, leveraging the 2x exposure to amplify daily gains. This approach requires constant monitoring and a good understanding of market trends.

Tactical Allocation

Some investors use SSO as part of a broader, tactical asset allocation strategy. They might allocate a small portion of their portfolio to SSO during periods of expected market gains while maintaining larger, more stable investments elsewhere. This balances the potential for high returns with overall portfolio risk management.

Hedging

SSO can also be employed as a hedging tool. For instance, if an investor holds a significant amount of non-leveraged S&P 500 ETFs, they might use SSO to hedge against short-term market declines or to amplify gains during expected bullish runs confidently.

Leveraging Market Sentiment

Sophisticated investors may use SSO to leverage specific market events or sentiment-driven trends (e.g., earnings reports, economic data releases) that they believe will lead to rapid and substantial S&P 500 movements.

Conclusion

SSO is a compelling investment for those looking to leverage gains in the S&P 500 over the short term. However, its daily reset feature, high costs, and compounding risk make it unsuitable for long-term holding. Investors should carefully consider their risk tolerance, investment goals, and market conditions before diving into SSO. By adopting the right strategies, such as short-term trading, tactical portfolio allocation, and hedging, investors can harness the benefits of SSO while mitigating its downsides.