As Double Leverage ETFs Push Market Volatility, Can They Blow Up?

Are ETFs Driving Late-Day Turns? - WSJ.com.

The article from the WSJ.com linked above (subscription required) puts forth the hypothesis that the 2X leveraged and inverse leveraged ETFs are pushing the market, especially in the final hour of trading.

The recent market action has traders waiting for the last hour, determining the market direction, and piling in. The leveraged ETFs are a popular vehicle to ride the direction of the final hour of the day. These ETFs have become some of the most active issues in the market.

Outside of the possibility that active trading in these funds is pushing market volatility to higher levels, I am wondering if there is a possibility of them blowing up at some point. Can they become the equivalent of program trading in 1987 or mortgage backed security trading in 2007?

A few days ago I wrote an article on one of these leveraged ETFs that hit shareholders with an 86% short term capital gains distribution. That seems to be a small clue that all may not be well in double gains and losses land.

I really do not have a clue if these ETFs can blow up. The gut feeling is that as their trading volumes grow there is a flaw in the structure that will bring it all down at some critical level. If anyone has any thoughts on this I am curious to hear them.

Comments

[A Different...:]

Quick look at associated long tickers ( Qs,SPY,DIA) , they appear to have same volume profile as short ETFs past few days

2008 Dec 17 09:07 AM

[carey_jim:]

The ProShares double inverse ETFs SRS and SKF deserve some analysis also.

SRS, for example, starts around May of 2007 at a share price of around $65 trading a few thousand shares a day and quickly rises to a volume of around 30 thousand shares a day.

SRS trades in a range between 65 and about 110 for a almost two years (disappointing its shareholders by seeming to completely ignore the housing crisis) with a short-lived break out to about 140 but by then its volume has risen to close to 10 million shares a day.

Then it has a quick double spike reaching a high of 216 and then plunges to a low of around 60 which is below its starting price but with a volume of 18 MILLION SHARES A DAY.

It looks like a sure buy but something is rotten in the state of Denmark, I'm afraid. (There's no free lunch on Wall Street unless the food is rotten.)

It seems that it is being used primarily as a convenient day trading vehicle only and I don't know what the consequences will be.

2008 Dec 17 12:20 PM