More on the Dangers of Leveraged ETFs

In regards to my posting on the dangers of leveraged ETFs on Wednesday, here's Morningstar's take on this that I just discovered while doing research today. They put out two short videos entitled “Returns at these ETFs Could Shock You.” Intrigued by the dramatic title, I watched them both, and am glad I did for they expand upon my article and explain in detail about the dangers of leveraged funds—the double longs and the double shorts--and employ graphics to show how that even a sideways fluctuation in the market (due to extreme volatility) can produce significant losses on both the long and short sides.

In doing their research, they said these leveraged ETFs perform as stated in their prospectuses. Performances over one day mirror +2x/-2x that of the indices they track.

The Morningstar recommendations are that if you can't monitor nor afford to trade these ETFs on a daily basis, you'll most likely not be happy with your returns. My take is to look at the historical charts and compare their underlying indices or comparable index funds. If there's a negative divergence, stay away, and do make sure that the fund has a long enough track record—at least a year. You would also want to see the fund cover a period of abnormal volatility (like now).

Comments

[Prudent Man...:]

Unfortunately, she doesn't address the conflict of interest of those who control the expansion and contraction of share outstanding as well as the illiquidity of the assets in the ETF resulting in inelasticity and the opportunity for manipulation by insiders.

Charts are ancient history in markets as volatile as this one. Any investor, and even traders who are not investor's whatever the NYSE, CNBC and FBN infer, must know how the ETF is constructed and who has powers to manipulate, who is auditing the ETF and who is regulating it.

Trading is a zero sum game. Therefor, for a trader to make any meaningful money several other traders must be losers. In my fifty years in the market, I have never, with the exception of the thugs on the floor, consistently make money and usually end up as "investors" with their cemetery portfolios funded with dead stocks.

Feb 15 10:06 AM

[Prudent Man...:]

My previous should be that I have never seen any traders who consistently made money.

Sorry for the poor editing on my party.

Feb 15 10:07 AM

[the ilster:]

these are great when you get the big multi-day moves where you are in for a week

Feb 15 02:08 PM

[outtafavr:]

Extreme volatility has distorted these ETF's performance. I would describe it as a mathematical phenomenon. But volatility is also a zero sum game. Calm waters, somewhere in the market's distant future, will allow these ETFs to perform as they were designed. I expect that future performance to compensate for the poor performance witnessed to date. While I make no predictions about the timing of what I'm talking about, it could certainly take years and maybe many years. Thanks to our author and other town criers like Cramer, very few investors will be on board for the entire ultrashort journey. I think it will be a fruitful journey and I, being a very patient and diligent investor, intend to ride it out. That is, unless City Hall shuts us down amidst all this hysteria about the dangers of an obviously risky investment.

Feb 15 02:10 PM

[poor old man:]

These ETF's are only good for daytrading. Look at a comparison chart of FXP( double short China) and FXI (long China) over a 1 year period, both are down over 40%. Huh. It's a scam, trade in and out daily, but don't hold.

Feb 16 04:34 AM

[je:]

Thanks Kris for trying to get the information out on ETF's.

I think that volume and liquidity play a great deal in to these. The OIH ETF is, as far as I have traded it, been very reliable to move with oil. I have watched the 2x on a few of them and could not find them reliable so I do not "labor" with them.

On the charting matter - when the market was in free fall I agree that the charts was of little use, but then neither was anything else. You were either in on the short side or you were being destroyed. Charts are the most reliable indicators of markets available other than inside information. Only those who refuse to study them disagree.

Feb 16 08:50 AM

[Sargasso:]

Great post, I haven't traded them but am forewarned now.

Thanks

Feb 16 10:32 AM

[adelante:]

Are the "Ultra" Indexed ETFs, such as UWM and SSO, considered "Leveraged"? I need to know, please. Thanks.

Feb 16 10:51 AM

[squark62:]

dr kris,

do you trade any of these leveraged etfs or do you just analyze them? if you do trade them, what kind of indicator do you look for to buy and sell?

thanks,
squark62

Feb 16 12:36 PM

[squark62:]

aleluja: this answer is YES.

UWM is 2x the russell2000 index and SSO is 2x the s&p500. go to www.proshares.com/ for more info. anything from proshares with "ultra" in the name is levered.


On Feb 16 10:51 AM aleluja wrote:

> Are the "Ultra" Indexed ETFs, such as UWM and SSO, considered "Leveraged"?
> I need to know, please. Thanks.

Feb 16 04:32 PM

[Kunst:]

Yes, those are both 2x funds (Russell 2000 & SP500).


On Feb 16 10:51 AM aleluja wrote:

> Are the "Ultra" Indexed ETFs, such as UWM and SSO, considered "Leveraged"?
> I need to know, please. Thanks.

Feb 16 04:33 PM

[Rocknbob:]

the referenced ETFs, DUG, UNG and USO are not leveraged, i believe , since they are meant to track variatiions in Oill and Nat Gas on a 1 :1 basis.How can they be? Are the references in the title erroneous? Am I wrong?

Feb 16 06:24 PM

[squark62:]

right from www.poshares.com in reference to DUG:

"ProShares UltraShort Oil & Gas seeks daily investment results, before fees and expenses, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Dow Jones U.S. Oil & Gas Index."

also note that DUG is NOT indexed to oil or natural gas. the underlying in DUG are oil and gad produecrs, oil & gas equipment, services, distribution cos and a tiny bit of alt energy. see www.proshares.com/fund...

now UNG & USO are NOT levered.


On Feb 16 06:24 PM Rocknbob wrote:

> the referenced ETFs, DUG, UNG and USO are not leveraged, i believe
> , since they are meant to track variatiions in Oill and Nat Gas on
> a 1 :1 basis.How can they be? Are the references in the title erroneous?
> Am I wrong?

Feb 16 07:46 PM

[MGA_1:]

TBT has tracked fairly well against the 30 year treasury - other shorts like SRS are a mess - I think you can make a lot of money (a friend did), but you need to be careful. Just make sure you know what you are buying and how it functions.

Feb 16 10:38 PM

[HiSpeed:]

UNG & USO are 1:1, not leveraged like DUG which is 2:1 "ultra-short" (DIG is the ultra-long counter to DUG)

Feb 17 07:29 PM

[MGA_1:]

USO uses futures contracts which can have unexpected consequences including contango

Feb 18 12:19 AM