3X Exchange-Traded Funds
When we made our buy ‘em call on October 10th, we wanted to avoid single stock risk. And, we wanted to have prudent exposure, while still maintaining some cash levels. Our solution was to deploy enough cash into 2 to 1 leveraged funds on the S&P (SSO) and the Nasdaq 100 (QLD) so that our managed accounts were 50% cash, and 100% effective market exposure. That worked out well.
Now, along comes an even more aggressive ETF: Triple upside and downside exposure. I have no opinion of these, as I have not really worked out the usages of this. It does seem a bit excessive, and my friend Paul absolutely hates them.
Here is the full run of triple leverage ETFs. I wonder if Rydex will come out with a competitive product or not.
Fund Name . . . Symbol . . . Benchmark . . . Leverage
Direxion Bull Funds• Large Cap Bull 3x
(BGU) Russell 1000 Index 300%• Small Cap Bull 3x
(TNA) Russell 2000 Index 300%• Russell 1000® Energy
(ERX) Energy Bull 3x Shares Index 300%• Financial Bull 3x Russell 1000 Financial Services Index
(FAS) 300%Direxion Bear Funds
• Large Cap Bear 3x
(BGZ) Russell 1000 Index -300%• Small Cap Bear 3x
(TZA) Russell 2000 Index -300%• Russell 1000 Energy
(ERY) Energy Bear 3x Shares Index -300%• Financial Bear 3x Russell 1000 Financial Services Index
(FAZ) -300%
>
Previously:
Paul Disses the Triple Leverage ETF (Video)
http://www.ritholtz.com/blog/2008/11/triple-leverage-etf/
10 Bullish Charts, Signals, Indicators (October 10, 2008)
http://www.ritholtz.com/blog/2008/10/10-bullish-charts-signals-indicators/
Source:
Innovative Funds Benchmarked to Help Advisors and Investors Seeking to Outperform
Nov 03, 2008 11:41 ET
http://www.marketwire.com/press-release/Direxion-Funds-916219.html
November 6th, 2008 at 7:20 am
In high volatility these funds only lose money over time. One is much better off buying deep in the money options to get the same effect without a time loss.
November 6th, 2008 at 8:22 am
John Borchers is exactly right. And I’m not even convinced they will work well as short term trading vehicles. There’s an old blog post floating around somewhere regarding viability of individual ETFs, noting that a fund must pass a certain asset threshold for it to become viable long-term and that many ETFs these days have not met the threshold and thus lose money for the fund creator and are being closed.
When volatility pushes these funds lower and lower over the long term, will the unit prices be reset (e.g. UYG is in the single digits today, if it ultimately goes lower and lower due to vol, would it be worthwhile to do a unit re-price? The underlying for Ultra ProShares are simply swaps, so as long as all unit prices are adjusted accordingly, should be ok).
November 6th, 2008 at 8:24 am
jmborchers: Explain a little further? Seems that equity/index options have the added issue of an expiration date that has to be factored into your deep in the money idea. Interested to learn how this compares to triple or double leverage trades? Do you not long/short options expecting a particular movement (or no movement) versus a leverage ETF that multiplies the effect of up-capture or down capture? Thoughts anyone?
November 6th, 2008 at 8:40 am
Read page 19 and 20.
http://media.proshares.biz/documents/ProSharesSAI.pdf
Right now the market is working in the highly volatile RED ZONE it’s swinging back and forth plus and minus. So each time the fund hits the minus side you lose even bigger.
Options do expire with time so that is something that has to be considered. But if you buy deep in the money options 6 months out in the worst case you’ve lost all your money. But if you’ve lost all your money on the option the market value is probably worse than that loss. You would have to trade in and out at 6 month intervals, but that’s not so bad.
November 6th, 2008 at 8:45 am
Mike J I would imagine they reset the fund price by doing reverse splits.
November 6th, 2008 at 8:49 am
I, for one, will use these instruments on a short term basis.
This from the guy who is buying callable cd’s the last month or two.
Frankly, if I want to make a short term bet on an ETF, the higher the ratio the better.
In my tiny little mind, an analogy would be the roulette wheel at Vegas…if I lose I lose x….(think of it as a sum of money and a bet…) if I win I win 3x. I am saying, if you wish to gamble in volatile markets like these, and you understand the risk, then you want as big a reward as possible. And yes, it would only be money I was willing to lose.
It is the same bet 10 to make 30 analogy…not investing for the long term, short term betting. NOT INVESTING….
November 6th, 2008 at 8:56 am
For example:
If I want to get what Barry wanted in a 2 X SPY I would buy the $50 call option on SPY expiring on Dec 2010. The price for those is $46.60 on the bid and $48.05 on the ask. In this case the asking price is 2% over the current market price of SPY (not a big deal considering you are allowed to hold these for 2 years).
Since the price is only $47 (approx mean for example) you could buy 2 option contracts for almost the same price as the SPY shares themselves. That’s how to get 2 X spy leverage.
To get 3 X SPY leverage you’d buy around the $60 call mark. But if the price of SPY falls below $60 you’ll lose the whole investment.
Also note if the market falls 50% from here with the double long funds you’d also lose 100%.
November 6th, 2008 at 9:19 am
jmborchers: I’ve read the pdf, but isn’t a trade in one of these instruments intended to take advantage of the volatility in the capital markets, not avoid it? Maybe I am taking a way to simple point-of-view here, but if I believe in a significant movement in one direction or another, these tools give me an efficient outlet to capture this movement. Index options seem to be a little less efficient and with the additional factor of time decay in pricing, they are not the best tool for this purpose.
At the end of the day, each has purpose that has cross-applications, but suggesting one is much better off using one over another may not be accurate.
November 6th, 2008 at 9:26 am
I actually love these things: the way Barry has described using them is very similar to what bond traders do when matching desired durations against smaller capital amounts. Using these also avoids the delta decay – or at least passes it along to Direxion – associated with buying the options necessary to accomplish the same thing. I guess one could buy deep in the money options and get the same effect, but even if you’re using the minis you’ll be paying a couple grand a pop; not especially feasible for small investors attempting to make round trades and an absolute no no in your retirement account (of course, why are you speculating in your IRA anyway, but I guess that’s another topic…).
Can you be wiped out using these? Absolutely. Should you be buying these as part of a buy and hold strategy in the first place? Absolutely not. If you like trading the indices, this is a great way to go provided you know how to manage your capital and risk. It’s not unlike anything else: if you are disciplined and know what you’re doing, it’s a great way to leverage. OTOH, If you’re a N00b (sorry), avoid like any other risky activity you know nothing about.
November 6th, 2008 at 9:31 am
John, you can only lose 100% if the target index drops 50% in one day. Not saying it can’t happen (see: Iceland), just saying.
November 6th, 2008 at 9:32 am
I think these are going to be great when the time comes to ride a Monster Squeeze™. Not for the faint of heart…
November 6th, 2008 at 9:34 am
If you want a lot of leverage on an index then why not trade futures? Are stock people that afraid of trying something new?
November 6th, 2008 at 9:41 am
agreed. Leftback.
How are your toes?
November 6th, 2008 at 9:56 am
Since the volitility kills the value of these funds couldn’t some smart guy short the ETF and expect to make $. To avoid market risk this smart guy would go short the 3X long and short the 3Xbear at the same time and come away with big $ assuming the volitility kills value.
Now since the market is smart shouldn’t smart guys already be doing this thus removing this arbitrage opportunity? I’m not sure how this would work in an open ended fund, but in a close ended fund there would be premiums or discounts built in based on expected volitility.
If someone has backtesting software please let me know what the return would have been shorting SDS and SSO over the last 12 months. My calculation based on share price is that the return was >10% but that could be substantially different based on dividends etc.
November 6th, 2008 at 9:58 am
Bruce, my toes are great. I am bearish this week. In fact, other than a long-term position in GDX I have been short since Monday and I doubled down on SKF on Tuesday, where I am sitting for now. How do you like the action in gold recently? That 5% up day was impressive, eh?
AT posted yesterday – he is invariably correct on the technical picture, and this time he was bang on with calling a top around SPX 1000. I went short as we approached the overhead resistance at SPX 1000, it seemed a perfect set-up for a correction. Unlike AT, who is calling for a wave down to 775, I am more inclined to see a bounce off support at around 900 or so, and then if volatility continues to moderate slowly, we should see a continuation of the rally, especially if stimulus packages and other reflationary measures are brought forward.
November 6th, 2008 at 10:01 am
Hey, first time posting on the new site.
One of the things, that I am very skeptical of, is that the new ETFs have gradually higher and higher expenses.
As a huge fan of the SSO (the old site will have my post pretty much with my timestamped entry and exit on the day barry put out his buy call and didnt name the funds), I am aware of its downside.
The SPY has an expense ratio of .08… The SSO is .9%. Combined with the volatility that Borchers noted, can result in some scenarios where a slightly up market would still make the SPY a better play.
I’d have to think triple leverage is going to have well over 1% expenses, a disgusting trend in the etf market. The original ETF’s were great. Low cost, buy 100 or 1000 shares for a low-ish commission, and you get some transparency. The new ETF’s use alot of hedges and options. This has always been true in some of the commodity funds (DUG still is a painful memory for me), but I would think is also true for some of the 3-1. Will market forces force the fund to behave as a true 3-1 fund? Maybe, but it may not be a true reflection once you look at the underlying NAV.
Mostly DITM calls are better, especially if you are trading as a fulltime job and can pick off an inefficiency I think, but for a variety of reasons alot of us might not be able to trade them (mostly for the same reasons I am hesitant to post here).
November 6th, 2008 at 10:08 am
you guys missed the point of WHY the fund doesn’t achieve its stated goal of 200% or -200% return: it’s naturally short gamma. what does this mean? the fund (let’s talk SDS here), on big down days, has to sell more stocks to increase it’s short exposure, and on big up days it has to buy back stocks. it buys high and sells low, and thus underperforms its target in volatile markets.
i happen to think the idea of triple levered ETF’s are horrible. we have margin constraints for a reason – because the average American retail investor is too stupid to effectively manage their own leverage – as Paul said in the video, they will trade themselves to zero.
I’m quite surprised in this environment in the wake of a leverage orgy that’s being unwound that we’re talking about products that INCREASE leverage. I guess Henry Waxman hasn’t heard about this yet – he’ll surely put the Direxion top brass on trial eventually..
November 6th, 2008 at 10:21 am
Fantastic comments !
November 6th, 2008 at 10:24 am
Kid is quite correct, these will be a nightmare in the wrong hands. I would only use these things for special situations, for example when there is a very high probability of a Screaming Short Squeeze. I can certainly see the FAS and the FAZ being a tempting play for those of us who have loved the roller coaster using the SKF and UYG.
November 6th, 2008 at 10:41 am
Lefty:
Calc. Risk last night published a memo from GS estimating the job losses Friday would be 300k rather that what everyone is expecting 200k…seems awfully bearish news for the end of the week.
November 6th, 2008 at 11:08 am
Multiple ETF’s (XXETF) are not just simple 3X or 2X, etc. of the ETF. 1st, low activity increases the spread of buying in and selling out. 2nd., if you multiply the % change of the ETF and the XXETF – you’ll see a variance trading at a premium or discount at the moment you want to make your transaction – the cause could be demand on one side or the other or a catching up of yesterday’s varience. 3rd. If you hold the XXETF for a multiple of days and the change in direction every day is in the same direction you will, indeed
be getting the multiple you thought you were buying. If each days direction goes up, retraces, goes down, etc. you will see your multiple go get watered down to less risk you initially took to more risk and a lesser return. Know the Facts – Read the Facts behind the security and their “Subject to’s”
November 6th, 2008 at 11:11 am
Finally, atleast Profunds – actually trades for as much as 15 minutes after the market closes – the swing in this 15 minutes can be attractive or damaging to your position. There are Options traded in these XXETF’s
and their spreads and catch-ups are not as good as the regular options….
November 6th, 2008 at 11:26 am
Anyone else happen to see the Inverse Head and Shoulders pattern developing on the daily SPY chart?
IF this pattern is valid, then it would suggest that our downside here is about 900, or 90 on SPY… but, I expect this shoulder to make a low around 93-92, as the second shoulder on these patterns usually mark a higher low than the first shoulder.
Of course, I am interpreting this pattern as a reversal pattern…. as Inverse H&S’s usually are, and are also common bottoming formations.
IF the pattern is confirmed, then it sets us up nicely for a retest of 1000 on SPX (100 on SPY)… a likely level for a breakout, both in terms of psychology, and in terms of where our little Obama Rally failed to breakout from…
I still believe yesterdays and todays selling pressure to be par for the course given how fast we ran up, and given the volatility levels we are seeing. Thus, I havent bailed on any of the longs I picked up a few weeks ago. Of course, I found the comments on the CSCO call to be troubling, but not outside of the realms of what was expected by realists. Bottom line is that we know things are bad, and it is reflected in just how far we have sold off…
What remains to be seen is how we plan on moving forward, and I would expect our new President to defer little time in announcing what he plans to do to address this mess.
November 6th, 2008 at 11:36 am
My background isn’t as technical as many of the posters on this topic. But I keep coming back to Warren Buffet’s statement about “Why are there so many new ways to lose money … the old ways still work pretty good. ”
Do the fund managers make out regardless of what happens? Then they are the only winners. All others are suckers who might be a little ahead for the moment. To me, waiting for S&P 900 or lower and then putting a few bucks down on just about anything is as close to found money as anything and probably as close to a sure thing as anything. Even if it still falls to 800 after I put some cash down. The world is only slowing down for a while, not ending.
The best advice ever given was to never invest in something you don’t understand. If it’s a new idea, maybe it’s only a crappy idea that has just found it’s time.
November 6th, 2008 at 11:38 am
I-Man
As Helene Meisler is fond of saying, if everyone sees the pattern, it’s probably likely to fail.
That said, a really good example of what you’re saying can be found here: it’s the Rydex S&P inverse fund, but the potential H&S topping pattern is way more evident (at least to my eyes), suggesting 1150 as an ultimate upside trading target. Well, at least, assuming the pattern is not so full that Maverick can’t get away with buzzing the tower anyway.
BTW, let’s see if all my fark-coding actually works. Hey Barry, any way of getting a preview function, or am I an idiot (I do realize that the two are not mutually exclusive: there is and I am).
November 6th, 2008 at 11:50 am
@ Byno:
I and I requesting a fly by.
Nice spot on the Rydex fund… it further confirms my analysis.
November 6th, 2008 at 12:58 pm
I’m pretty bearish about the near term. We’ve had a whole bunch of distractions the past couple of months – the financial meltdown and the election – that now that the economy is seriously tanking and we are entering a seemingly ‘rudderless’ interregnum – that the bad economic news (retail sails way down, mnufacturing way down, employment way up) suddenly pushes itself to the fore and seizes the national attention. I see this as probably another big leg down, as opposed to a snap back from the brief run-up.
November 6th, 2008 at 1:24 pm
I don’t trust these ETFs. I have several years of futures trading experience with a background in mathematics and finance, and I cannot figure out how they can maintain the performance they seek. There must be some fantastic slippage at extremes. When one shorts an index, you can lose an unlimited amount of money….so how can you have a leveraged short index where you’re downside is capped at ZERO? On the flipside, if go long this 3X ETF and the market falls another 50% from here, then how can you lose 150% on your investment? These ETFS do stop at ZERO, right? The only way I can see them attempting to do this involves inbedded options which cost premium, so that’s where the slippage must occur. Anyone with more background in math may be able to give me a better idea about how they can do this….
The other issue of course is the one Kedrosky is pointing out. These instruments are starting to resemble futures on indexes, and last time I checked, investors are supposed to be vetted before opening a futures account. I know that it’s a lax check these clearing firms do, but the point is inexperienced traders are not supposed to be hanging out doing futures. Also, the people who open futures accounts have to meet some minimum net worth requirements. These ultra leveraged index funds seem to be circumventing some of these requirements.
- AT
November 6th, 2008 at 1:39 pm
AT, what do you think of I-Man’s analysis above of the inverse head-and-shoulders? I am also calling for a bounce off 900, but on the other hand I am staying short until the bounce arrives……..
November 6th, 2008 at 2:15 pm
Can anyone recommend a method for shorting the way SDS does that I would be allowed to use in my IRA?
I understand (but have not verified) the argument about a kind of friction loss during directionless volatility. It does seem to be less than the simplest equation would suggest. (Where a 1% up day followed by a 1% down day results in 0.98*1.02=0.9996)
I use both URPIX and SDS. URPIX does stay much closer to its stated targets than SDS but because it is a mutual fund, it can only be sold at the end of the day.
As to why anyone would “speculate” in their IRA. I am at least a decade and a half from retiring and even after the rally on Election Day, my IRA was up nearly 60% for the year. Over 70% now. If I had followed Barry’s advice and waited longer before going short, I would be closer to retiring.
November 6th, 2008 at 3:05 pm
For an investor/trader will the margin requirements for 3x funds at a typical broker still be the same?
- Schwab has a 30% margin maintenance requirement for the 2x funds I looked at.
- 3x leverage on 2 to 3 times margin gets you a lot of exposure fast, but man, it also sounds like a recipe for disaster.
OT – anyone like Schwab’s new site? I give it a B right now.
November 6th, 2008 at 4:20 pm
Good points. Even if Barry bought SSO on the optimum day, he’s only up 10-15%, with a phenomenal amount of risk.
The one problem now with deep in-the-money puts is that they often need to be VERY deep in the money. But over the last few years, my best trades were deep in the money LEAP puts.
I’ve been using put spreads, but they have their own timing problem. You either have to market time accurately, and/or be somewhat conservative. I was too conservative with some steel spreads. I had JAN 2010 70/115 spreads on MT that cashed out last month! (MT is now at 20.
But there was no in-the-money puts available at the time that didn’t have a humongous premium. Needless to say, I didn’t expect it to crater that far, that fast.
November 6th, 2008 at 4:29 pm
Actually, if Barry bought SSO on Oct 10th as he implies, he paid 29, it’s now at 28. SPY is up a couple bucks.
Did he really put half these clients’ accounts in these things?
November 6th, 2008 at 5:43 pm
leftback at 1.39pm…
On the S&P500 I don’t really see any inverted head and shoulder pattern that suggests a bottom. I see some shoulders…but I see no clear head. Perhaps with a leveraged ETF there exists a head, but I wouldn’t base trading decisions on a leveraged derivative of the actual index.
895 on the SP500 Futures is a 61.8 retracement and I can certainly count out a completed initial move down from the 1007 highs as well as some short bullish RSI divergence….so perhaps we will get a decent bear market correction from 895-900 zone. I’ve covered shorts and am currently flat. My bias is to wait to see a rally to sell into…not be long hoping for a rally. However, I’m a fairly conservative technical trader….if I were a little looser I would certainly be taking a shot at a little length waiting on a bear bounce.
- AT
November 6th, 2008 at 7:17 pm
The amazing thing is that AMTD will let you buy inverse 2x etf’s in your IRA.. you can’t short in an IRA so why is this slipping through the cracks?
November 6th, 2008 at 7:32 pm
JMBorchers… don’t forget you have to pay the bid/ask spread on both sides of the trade so your slippage is actually 4%.
In my day trading account I can lever up the SPY 4x, the spread is a couple cents, I can buy or sell in the aftermarket, and I don’t have to pay margin if I close in the same day.
If I want to put on a levered position for more than a day or 2 I would use in the money options.
Right now being 50% long is crazy enough for me.
November 6th, 2008 at 8:38 pm
I don’t know how people use these crazy leverage funds. I mean, isn’t that what got us into this mess to begin with? There is simply no way to manage risk when the SP’s are moving 3, 4 , 5%+ per day and these inverse funds are making daily moves that are the size of annual SP returns. It’s totally imprudent, in my opinion, to use these crazy funds. 3X is just insanity….But people will buy them and pay the fees….
November 6th, 2008 at 10:39 pm
Unfortunately SSO is not 2x SPY or the S&P – on the way down you get 2x, but on the way up you get less than that. Take a look at the intraday action 11/6, each rally was 1 for 1 percentage wise with the SPY while you fell at twice the rate. Anyone using this to daytrade long had little chance to make money. Holding for a 2 week period – S&P 950 sometime around 10/6 to S&P 950 after the end of the month rally actually lost you 20% instead of breakeven.