Leveraged ETFs

A recent blog by Felix Salmon, now publishing his blog through Reuters, covered an important topic for option traders. It re-emphasized the importance of not holding onto a long position in any leveraged ETF. If you want to own a specific ETF, then please buy the regular, non-leveraged shares and then adopt your favorite options strategy using those shares.

Here is the slightly shortened version:

Why the SEC should look at levered ETFs by (Felix Salmon)

TBT, the ProShares UltraShort 20+ Year US Treasury fund, is an ETF which returns double the daily decline in an index linked to long-dated government bonds. There are 173 million shares outstanding. Average daily volume is just 10.7 million shares — which means that the overwhelming majority of TBT shares are not traded on any given day.

The helpful bloggers at Symmetric Info have explained in great detail — here’s Part 1 and Part 2 — why this is bonkers. But suffice to say that no one should ever hold a leveraged ETF overnight. [Emphasis mine, MDW] These things are intra-day trading vehicles; they’re not medium-term or even short-term investments.

I think there’s a strong case for the SEC to step in here and take a very hard look at TBT in particular, and levered ETFs in general. ETFs with embedded leverage are clearly being bought by people who aren’t day-traders, and who have no business buying these securities. It’s the SEC’s job to protect those people. It should get on the case.

I’m very pleased to see a well known blogger – someone who is not in the options space – bring this problem to the attention of a larger audience. Adam Warner at (the sadly no-longer-being-published) Daily Options Report has done his part by writing about this problem.

In my opinion, it’s a true scam. Sure, the fund management probably mentions all the necessary warnings in the prospectus, but investors are notorious for not reading such documents. No one in his/her right mind would ever buy and hold leveraged ETFs. They are constructed to incur large trading costs, but more importantly, they are designed so that it is inevitable that they will not provide the promised returns.

It’s just one more way that Wall Street takes advantage of the little investor. However, from the example used by Felix, there seems to be plenty of ignorant big players holding these shares. I’m rooting for the SEC to get involved.

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