The Company

The News

A bad Thursday for investment-banking heavyweights like

Merrill Lynch

Lehman Brothers

The exchange-traded fund uses futures derivatives to bet against the Dow Jones U.S. Financials sector stock index, which closed down 3.6% Thursday and is down 16.4% year to date. There are 292 companies in the financials index, but it's dominated by big banks like Bank of America, Goldman Sachs and Merrill, and large insurers like AIG and MetLife.

Shares of the largest investment banks fell Thursday after Keefe Bruyette & Woods analyst Lauren Smith lowered first-quarter profit estimates for the big brokers an average of 37%, citing continued fallout from the subprime mortgage crisis, particularly in the commercial real estate sector and its related securities.

"There has been significant deterioration in the market for commercial mortgage-backed securities as evidenced in part by the sharp decline in the CMBX index, which tracks the performance of commercial-real-estate bonds with different credit ratings," she wrote. "We believe the large cap brokers will mark down their CMBS holdings in 1Q08 given the widening of spreads between Treasuries and the commercial mortgage backed securities by about 5%."

Smith lowered estimates for Merrill, Lehman, Goldman, Morgan Stanley and Bear Stearns.

The Analysis

Thursday was made for an ETF like the UltraShort Financials. It uses enough leverage to double the inverse results of the financials index, providing a short-term pop when financials sag.

And those stocks have been sagging ever since the subprime mortgage crisis broke into the open and picked up momentum, resulting in losses of billions and billions of dollars throughout the sector. Of the stocks whose estimates were trimmed Thursday, top performer Goldman is down 16.4% over the last year, while Citigroup shares have lost 56% of their value.

UltraShort Financials is up 65.7% in the same period, while the underlying U.S. Financials index has sunk 29.3%. The ETF is more than double the index loss because its returns are compounded.

ProShares Chief Executive Michael Sapir says the Ultra funds family "isn't targeted to mom-and-pop investors.

"But for more sophisticated investors who have a viewpoint that the financial sector, including the major money center banks, is going to do poorly as a result of things like the subprime mortgage crisis, this represents an easy and simple way for investors to get short exposure to the sector," Sapir says.

Making sector calls, particularly is you use ETFs to bet on an industry's falling fortunes, is more risky than the average investor's do-it-yourself strategy. That approach can still work, says Virginia Zart, senior web editor at Global Trends Investments, a Newport Beach, Calif., advisory firm.

"Setting up an exit strategy is important," she says. "We watch the 200-day moving average and put an 8% stop-loss on [each ETF]."

The Bottom Line

Because it's tracking an index, an ETF will have lots of day-to-day volatility, but if the underlying sector story holds up, it can be a rewarding, if nerve-wracking ride.

In the case of the UltraShort Financials fund, CEO Sapir says plenty of hedge funds and university endowments use it to avoid the risk of directly shorting individual stocks themselves.

"To go short on a security you have a potential for unlimited loss, and for most people, it's an overly daunting process," he says.

But a short-biased ETF isn't just a way to profit in a down market it can also be used to hedge losses in a balanced portfolio and adhere to a longer term investing strategy.

The subprime mortgage crisis has spilled over far and wide, and the financial sector will keep hurting for some time. The big banks start reporting earnings March 18, and that may offer some visibility on their damage-control efforts.

If you're using the UltraShort Financials ETF to stay above water, you need to keep a close eye on the flood of news about the sector. You can do well, but you can't call a short ETF bet a balanced investing strategy "until you have a plan to get out," says Zart.