Tag Archives | leveraged ETFs

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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What other bloggers are saying

New Volatility Products

Bill Luby, of VIX and More, responding to my question:

Volatility has become a quagmire of products. I like your idea of taking advantage of opportunities that you see, but I don't have the time or patience to dip a toe into this pool. Is that a big mistake?

"I am a strong proponent of only trading what you are comfortable with and know the intricacies of. Unfortunately, these VIX-based ETPs require a fair amount of study to sort out how and when they should be applied. So in the generic sense, I'd say these are not essential products to the random investor.

Ultimately I think the VIX ETNs are going to be best utilized by short-term traders making speculative plays. They also have a place in the portfolios of investors who are looking to hedge their holdings against volatility. Now that a new generation of products are being unveiled, I think the potential for pairs trades in this space has just increased exponentially. I'm not sure how much I am going to get into this, but the opportunities here for the serious and determined student of volatility ETPs are very substantial, IMHO."

 

Leveraged ETFs

Jared Woodard of CondorOptions on leveraged ETFs:

"When leveraged and inverse ETFs were first launched, many investors weren’t aware of the negative effects that daily rebalancing would have on the long-term performance of those ETFs relative to their benchmarks. Those potential problems are now more widely known, and coverage of leveraged and inverse products often includes the advice that they are best used as trading vehicles rather than investment products…

There’s a larger point to be made here: the complexity of modern financial products clearly outstrips the ability of investors to understand them, even when relatively “sophisticated” (e.g. the kinds of people willing and able to trade inverse/leveraged products) and are presented with proper disclosures."

Jared quotes research suggesting that the message still hasn’t gotten through:

"We find that many investors hold their leveraged ETFs for very long periods, at times longer than three months. Further, we calculate the shortfall of such a behavior compared to creating the leverage in a margin account, is that some ETF investors lose up to 3% of their original investment in just a few weeks, the equivalent of a 50% annualized return. This indicates that investors do not fully understand the risks associated with inappropriately using leveraged and inverse ETFs as long-term investments."

MDW: I recognize that option strategies are attractive when owning ETFs.  Please don't own leveraged ETFs.

 

Technical Analysis

I don't use TA, but this advice from SMB Training is priceless:  [hat tip Derek]

"Don’t trust what you read or what you have been taught.  You have the same information that the authors did (price data: raw numbers and charts) and two eyes!  You can, and must, do the research for yourself.  Look at 500 examples of support levels on all timeframes and draw your own conclusions.  What you verify, and what you learn, from this process will be so much more useful to you than what you read in a book."

The age of viral information by Rick Bookstaber

"Information is moving from being the bedrock of market efficiency to a source of crisis…

The greatest concern lies in inconsequential information going viral. For those in the market who are on top of the news and its implications, the question no longer is simply one of when others will finally get around to looking at the information and see that it is important. It is also a question of whether something irrelevant will catch the fancy of the crowd…

The new, viral world means more surprises and more volatility; and not because of market shocks precipitated by content, but because of the randomness in what might happen to catch on and reverberate through the internet."

 

The Insanity of Bailouts: Barry Ritholtz offers this (The full post contains much more):

"What is more important than survival?  On planet Earth, nothing. The most basic rule of life is SURVIVE.

Entities that are maladaptive — corporations, nonprofits, governments — eventually succumb to their own mortality and collapse. This is as it should be.

This is especially true when it comes to financial firms — banks, insurers, investment houses — whose prime responsibility is identifying potential reward and managing risk. The failure of survival raises a compelling question: Why should firms that fail their most basic charge — survival — be bailed out? If on their own they are too incompetent to merely continue to exist, what other manner of disasters live within their balance sheets, legal obligations, managerial skill sets?

A firm that is so reckless and irresponsible as to have put its own survival at risk is not only maladaptive — it has failed its most basic duty."

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Merry Christmas to all

Happy New Year!

 

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