The Lowdown on 3X Leveraged ETFs

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Includes: ERX, ERY, FAS, FAZ, SPXL, SPXS, TNA, TZA
by: Everyday Finance

Back in May when I reported that 3X ETFs that triple the return of various indices were coming, I was already conjuring up various financial models to exploit whatever market conditions may present themselves when the launch was finalized. Well, that time is here. Direxion has launched the following 3X Long and 3X Short ETFs. I've outlined tickers and descriptions below, but be sure to review various options for investing as well as risks below.

Bullish:

Symbol/Class/Index

(BGU) Large Cap Bull 3x Shares Russell 1000 300%

(NYSEARCA:TNA) Small Cap Bull 3x Shares Russell 2000 300%

(NYSEARCA:ERX) Energy Bull 3x Shares Russell 1000 Energy 300%

(NYSEARCA:FAS) Financial Bull 3x Shares Russell 1000 Financial Services 300%

Bearish:

(BGZ) Large Cap Bear 3x Shares Russell 1000 -300%

(NYSEARCA:TZA) Small Cap Bear 3x Shares Russell 2000 -300%

(NYSEARCA:ERY) Energy Bear 3x Shares Russell 1000 Energy -300%

(NYSEARCA:FAZ) Financial Bear 3x Shares Russell 1000 Financial Services -300%

  • Obviously, given the 40%+ decline in major indices and close to double that for Financials, if you pick the bottom, you can realize an enormous return on the way back up. Do you think oil's headed back to $100+ when the global economy recovers? Then, ERX is the trade for you! However, picking the bottom is an act of god, so you'll definitely want to inject some caution and pragmatic thinking into your strategy.
  • There are various pairs/combos you can use for these. For instance, you can go long 3X with puts to create a neat hedge model, or you could use the 3X inverse to hedge the more significant long portion of your portfolio.
  • See my recent post on Selling the Rallies going short each time the market moves 10% or more up; there's been a repeating pattern since September, given the unprecedented volatility. (Of course, I didn't realize these were out yet and only used 2X, but 3X provides even better action).
  • I also recently posted on using leveraged ETFs with the VIX volatility play. The options are endless; and on that...these instruments have options listed as well, but given the new launch, the spreads are pretty wide and the volume is down. You may want to wait a while before trying to trade options on these.

Risky Business

  • I don't intend to beguile you with promises of great returns without requisite risk. Anyone that was 2X long in the equities, especially the Financials or Emerging Market ETFs from the beginning of the year...they've been completely crushed.

Counterparty Risk:

There is also counterparty risk to consider. According to the Prospectus:

  • The Funds may invest in financial instruments involving counterparties for the purpose of attempting to gain exposure to a particular group of securities or asset class without actually purchasing those securities or investments, or to hedge a position. Such financial instruments include, but are not limited to, total return, index, interest rate, and credit default swap agreements, and structured notes.
  • The Funds will not enter into any agreement involving a counterparty unless the Adviser believes that the other party to the transaction is creditworthy.

We all know what happens when an esteemed institution (or rating agency) makes assertions about the creditworthiness of an entity! So, in short, don't put your life's savings into these leveraged ETFs. It should be trading money that in the event of a counterparty default, you could survive.

Tracking Error:

  • A Fund may have difficulty achieving its daily target due to fees and expenses, high portfolio turnover, transaction costs, and/or a temporary lack of liquidity in the markets for the securities held by a Fund.

This is common for ETFs, but worth mentioning and monitoring to ensure you feel the ETFs are adequately providing the returns anticipated.