My Love Hate Relationship with Leveraged ETFs

Leveraged ETFs have been the rage, the the talk of the town since late 2007 and early 2008. They seem to be the primarily tool of want to be day traders, and they can work for you too! But they have a darker side, a side that makes me feel bad about putting money in them, a side that may not be safe for anybody.

What am I talking about?

ETFs (Exchange Traded Funds) are financial instruments that were designed by the SEC and various fund managers to provide low cost index following opportunities for investors. This means that management fees are below what a mutual fund would charge with no load and always a present value during market hours (unlike mutual funds that only close you out at the end of the day. ETFs by themselves can provide some layer of diversification in types of investments (but do not guarantee diversification.)

Then, invesco made the short and powershares family of funds that attempt to mimic a short position in the market, or 2x bull or bear the market. Naturally, other fund managers decided to offer similar opportunities and last fall the 3x bull and bear funds by Direxion came out.

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To list a few of these that I\’m active in:

  • FAS/FAZ 3x Bull/Bear of Russel 2k Financials
  • BGU/BGZ 3x Bull/Bear Large Cap Russel 2k
  • SSO/SDS 2x Bull/Bear S&P 500
  • DOG – Short DOW (GT Student Foundation held this for a while)

The Great

If you want to try market trend trading, what I would venture to suggest as a small form of short term trading very close to day trading, new and old users can get in these funds and track the trends. The market is headed up, great! Headed down, I can follow that too.

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But the Ugly

First of all, these are dangerous because they\’re mad volatile. They are even more dangerous to the novice because, they are not priced exactly, and have intraday prices marked the same way a stock does (bid and ask) only to be reconciled at the end of the day. So a 1% market gain could mean a range of 1.8-2.2% action in your ETF.  Then there\’s that volatility, you know, that index that rose through the roof as the market hit bottom last November, the 2% swings at the end of the day!

The Thing I Hate though is that these are effectively driving away the actual idea of investment. Options tracking an index have such a little positive effect on an underlying company that we are now just trading financial instruments that have an effect on the market… meaning companies like GM could be going out of business because they don\’t need capital because all of our investments are in \”financial instruments\” of options so disconnected from actual success. A bank could lose all form of market value because nobody is willing to invest in them instead of just trade their options.

I encourage you to look at your portfolio and consider that you put some of it in actual companies and not just financial instruments. Have a positive effect on capitalism, and hopefully through that, the world as leaders are altruistic with their gains. Or, by all means, consider some regular ETFs that invest in actual companies.

Learn more about these

  • here http://www.direxionshares.com/
  • http://www.invescopowershares.com/