All Original 3x ETFs Are Down Over Last Six Months

Over on the Seeking Alpha site, there is a lively debate on my article on 3x ETFs. Many commenters note that Direxion says the funds are intended to track daily changes (on a leveraged basis) and may or may not track changes over a longer period of time.

Good point. But if it was just a tracking issue, then we would expect that some of the ETFs would outperform their targets, some would match the target, and some underperform.

That’s not what happened. Every single one of the original 3X ETFs — both bull and bear — is down big over the last six months. That’s not a function of a tracking error. It's a structural flaw in these instruments.

Volatility destroys the value of 3x ETFs over any prolonged period. So a passive investor using these ETFs to “allocate capital” is not just making a directional bet. He or she is making a bet that the underlying market will trend persistently, with little volatility. Good luck with that.

As some of the comments mention, these quirks may offer an edge for traders willing to take the opposite positions. For example, rather than buying a 3x bull ETF, a bull might short the 3x bear ETF (or enter a bullish position with puts or selling a call spread on the bear 3x ETF). I’m intrigued — have any of you been able to do this in size?

Smallcap bull/bear 3x ETFs (TNA/TZA)

Largecap bull/bear 3x ETF (BGU/BGZ)

Energy sector bull/bear 3x ETF (ERX/ERY)

Financial sector bull/bear 3x ETF (FAS/FAZ)

DISCLOSURE: No position.

Comments

[WorkerOnWal...:]

To make money, you don't play in the casino.... you RUN it!! You have to be a banker or insider on Wall Street. Everyone else loses nearly all of the time.

Apr 26 09:04 AM

[Alan Brochs...:]

While I think that you as the author most likely understand what I am about to say, I am sharing this for the benefit of anyone who concludes that 2X or 3X ETFs are easy money shorts due to "structural flaws".

Note that the market has done "nothing" over the past six months. Actually, that is the furthest thing from the truth, as it rallied into January rather sharply after plunging into November, plunged again into March and then staged one of the most powerful bear market rallies ever. Lots of dust and fury, but no net change.

The above environment is the absolute worst one for these leveraged ETFs, which work best in a trending market. The triple-long ETF keeps buying as the market rallies and then sells as the market falls. If the market moves a lot but returns to its starting point, it gets whip-sawed. In that environment, you can make money shorting the long and short leveraged instruments, though you might lose a lot of sleep in the interim. The secret is that you never rebalance as you should do if you are hedging.

In the best environment, you can go long both and make money as the market rallies or falls, as long as it is a one-way train. Allow me to share this example:

Index value = $3
triple long = $1
triple short = $1

Let's do a 4-month example, where the market rallies 10% each month. Let's keep it simple and assume that these moves happen all on the last day of each month.

End of month one: Index 3.30, TL 1.30, TS 0.70
End of month two: Index 3.63, TL 1.69, TS 0.49
End of month three: Index 3.99, TL 2.20 TS 0.34
End of month four: Index 4.39, TL 2.86, TS 0.24

The index increased 46% (10% monthly, compounded)
The Triple Long increased 186%
The Triple Short fell 76%

Note that the TL made more than 3X the return of the Index due to compounding, while the TS fell a lot less than 3X (again due to compounding - losing the same % but on a lower value each month).

Now, here's the point I wanted to make. In this example, if one were to buy a unit each of the 3X Long and the 3X Short, he would have ended with 3.10 on a 2.00 investment. He made over 50% return on a "hedged" investment while the guy who was 100% long made "only" 46%. Note that the investment was "hedged" only on day 1 and the amount of money on the long side quickly dwarfed what was remaining on the short side.

Anyone who thinks that they can make money shorting both sides, I urge them to make sure that they understand that they will get wiped out on a huge directional move that doesn't reverse.

Apr 26 09:09 AM

[Alan Brochs...:]

I wasn't through my first cup of coffee... Not sure why I started the index at 3, so allow me to change the table (it has no impact on the percentage results):

End of month one: Index 1.1, TL 1.30, TS 0.70
End of month two: Index 1.21, TL 1.69, TS 0.49
End of month three: Index 1.33, TL 2.20 TS 0.34
End of month four: Index 1.46, TL 2.86, TS 0.24

Apr 26 09:15 AM

[Rick9264:]

Interesting coments. But, the "proof in the pudding" is your financial statement after doing 3x trades. I am a beginner in the area, BUT ... have done several 3x trades over the last month or so. My financial statements came in .... all my trades made money. I was very, very lucky and guessed the direction of the market and the direction of the financials. My return on "real cash" for my 3x trades - so far - has been 2.5%. This return is for one day ..... 2.5% return on cash for a day is not bad at all .... "me thinks. I used simple "guess-onamics": looked at the pre-markets, the asia markets and europe prior to making guesses on the 3x trades. Lucky so far.

p.s. I have also started to invest in high yielding ETFs .... so far the dividends keep rolling in the ETFs (some CEFs) keep appreciating in price. More luck ... ? Or is this what the active managers are doing in the world of mutual funds? Interesting world.

Rick

Apr 26 09:33 AM

[MGA_1:]

There are articles about the structural flaws inherent in these ETFs - I called schwab about shorting the proshares ETFs but they won't accept a short order. Has anybody been able to short any of these double/triple ETFs?

Apr 26 10:32 AM

[searcher:]

Many retail investors interested in ETF's are in tax advantaged accounts and their custodian will not allow them to short these.

Apr 26 01:30 PM

[chinooking:]

yes i have been able to short faz thru scottrade,,tho im currently under the belief that we have bottomed in financial's and am buying fas on a daily basis ,,,new's withstanding ,,in that belief ,,,,but it is a trader's mkt,,look at last mondays bear attack on no new's,,definitely not a buy and hold situation these day's


On Apr 26 10:32 AM MGA_1 wrote:

> There are articles about the structural flaws inherent in these ETFs
> - I called schwab about shorting the proshares ETFs but they won't
> accept a short order. Has anybody been able to short any of these
> double/triple ETFs?

Apr 26 01:57 PM

[yk00002:]

Please read the prospectus. The funds are doing exactly what they are supposed to do. If you want them to do something else please start your own ETFs. If you don't like them don't trade them. I like them the way they are.

Apr 26 02:34 PM

[Gary Gallo:]

And FAS is up 360% in just over a month. Got to love it!!

Apr 26 05:32 PM

[Gary Gallo:]

Simple math. Something goes down 50% you need a 100% gain to get back to where you were. Buy them under$10.00, under $5.00 is even better. That a way!

Apr 26 05:34 PM

[lo maximo:]

Why would anyone want to short (Bull) FAS? Just buy (Bear)FAZ. Forget about tracking how the 3x Bulls and Bears do over long periods of time. I bought calls on the FAZ.... FAYEI...the May 9's....for $1.85 and sold them 2 days later for $4. It's a short term directional bet. They are not designed for Buy and Hold. I sold them at $4 because that was all I expected to get. Glad I did. They fell back the next morning. Pick your spots.
Don't anticipate, guess or hope. Buy as you see the (Bull) FAS and XLF falling...and (Bear) FAZ heading up.....And don't let the sun set on the trade unless you see financials are weak. If financials are perking up, dump your BEAR calls. You'll get another chance.

Apr 26 06:21 PM

[Momintn:]

If you are in 3x ETFs, you better watch them every day. They are basically for a trade, not for a six month investment.

Apr 26 09:20 PM

[Biff Nixon:]

Here is a cheat sheet I Keep for X3 ETF's
with the screener set to Optionable and Shortable...9 ETF
finviz.com/screener.as...

3X--ETF'---Complete List

Direxion 3X ETF
Funds are not appropriate for "Buy and Hold" strategies, especially in volatile markets.

BGU,TNA,ERX,FAS,DZK,ED...

Stock Screener - Snapshot BGU,TNA,ERX,FAS,DZK,ED...

Bull
BGU Large Cap Bull 3x Shares Russell 1000
TNA Small Cap Bull 3x Shares Russell 2000
ERX Energy Bull 3x Shares Russell 1000 Energy
FAS Financial Bull 3x Shares Russell 1000 Financial Services
DZK Developed Markets Bull 3X Shares MSCI EAFE Index
EDC Emerging Markets Bull 3X Shares MSCI Emerging Markets Index
TYH Technology Bull 3X Shares Russell 1000 Technology Index
MWJ Mid Cap Bull 3x Shares Russell Midcap Index

Bear
BGZ Large Cap Bear 3x Shares Russell 1000
TZA Small Cap Bear 3x Shares Russell 2000
ERY Energy Bear 3x Shares Russell 1000 Energy
FAZ Financial Bear 3x Shares Russell 1000 Financial Services
DPK Developed Markets Bear 3X Shares MSCI EAFE Index
EDZ Emerging Markets Bear 3x Shares MSCI Emerging Markets Index
TYP Technology Bear 3X Shares Russell 1000 Technology Index
MWN Mid Cap Bear 3x Shares Russell Midcap Index

Apr 30 01:56 PM

[Biff Nixon:]

Live Link for Screener filled with all 3X ETF's
finviz.com/screener.as...

The other one did not publish

Apr 30 02:04 PM

[one eye:]

Freya is up 100% on FAS with her Buy/Hold strategy. She still holds it.

I'm up only 24% but I've held on to it for only a week.

Unbeknownst to her, I picked up DXO around $3 because she has been holding it for over a month.

You spot a Trend, you buy and hold until that trend changes.

Bill: Thanks for the ERY, I plan to hold DXO until Oil whether WTI or Brent approaches $64. I'm not greedy, that's her target.

May 09 12:37 AM

[Freya:]

I'm so sorry for you, I bought FAS at 9.79, way back after it had already plunged, I held on through the continued drop to the 2.60 area, Bought 4 times as many when it started to rally in March, reducing my average cost to 6.00 and have a very large overall profit.

As far as I'm concerned, I Will buy More if it revisits The lows. And while I do not expect the Banking sector to return to its former Glory, I do expect FAS to retrace 50% of its drop since inception eventually.

They can be for a trade or Forever. It Depends on your style of investing. Trading is gambling on a minute by minute--or less-- basis.

Apr 27 02:08 AM