Leveraged ETFs: Making Volatility More Volatile?

Here we see the five-minute ES futures for Friday, plotted with a 20-period volume-weighted moving average. Note how volume and volatility picked up dramatically around the 13:00 PM hour, with the announcement of bank stress test details. Twice in the day, we saw buying interest peter out at new highs for the day, followed by violent selling and equally herdlike buying. This created volatile oscillation around the VWAP, trapping buyers and sellers alike.

We've been seeing an increasing amount of this herdlike intraday behavior, especially in afternoon stock market trading. This is playing havoc on short-term traders and also longer-term swing traders, who find good positions quickly going bad. There is speculation that leveraged ETFs are contributing to these bandwagon effects, which could ultimately generate 1987-style portfolio insurance-style risks for the market.

Here is the original article that outlines how frequent portfolio rebalancing among leveraged ETFs "magnifies intraday movement". What this suggests is that volatility itself is becoming more volatile as an increasing number of leveraged ETF participants join the market. Friday's trade may just be a harbinger of things to come--and adjustments traders need to make.

Comments

[Marc Gerstein:]

I think it's way too early to be doing studies like these.

Leveraged ETFs came out in late '06 and really got going in '07 and '08. Can't we think of other things that might have caused increased market volatility, such as issues surrounding an epoch credit crisis and challenge to the viability of our financial system, not to mention the recession that went along with it.

Even as to the chart above, wouldn't the bank stress test details be sufficient to cause increase market angst whether or not leverage ETFs existed?

The study that was referenced above was done by Barclays, which seems to have a sizable axe to grind in the ETF world, and which is not in the leveraged segment of the market. Might that have motivated them to start crunching numbers years before we can accumulate enough data to get viable samples?

Just a few thoughts.

Apr 27 02:29 PM

[doubleguns:]

What about the govt plunge protection teams maybe adding to the volatility. Not to mention the hedge funds and banks maybe trying to get some capital. The banks listed a fair amount of trading revenue as income last quarter. Maybe they are till screwing us out of our money.

I could maybe this all day. Point is I believe there are a lot more forces at work here than some 3Xetf's creating all of these problems. You give the leveraged ETF's way to much credit.

Apr 27 05:36 PM

[inthemoney:]

> Leveraged ETFs came out in late '06 and really got going in '07 and '08. Can't we think of other things that might have caused increased market volatility, such as issues surrounding an epoch credit crisis and challenge to the viability of our financial system, not to mention the recession that went along with it.
----------------------...

We see 2% moves almost on daily basis in the last 30 min of trading. I think it is a high time somebody looked into this. If it was the economic situation that made the market super-volatile, it would've been distributed throught the day (and there is some of that) but the 90% is in the last 30 min.
For anyone watching markets daily it is very very obvious. A lot of people can actually predict the moves, and front running them, thus making the move even bigger. The last 30 min move is usually the opposite of the move on that day, but in the direction of the previous day (if that was opposite). If the previous day was in the same direction, then the last 30 min is in the direction of the day.
Now, if I can figure it out, what the Wall Street wizards with power tools are doing with this information, what do you think?

Apr 27 11:34 PM

[Luck-o-the-...:]

inthemoney
Leveraged ETFs actually STOP creating or redeeming shares in the last 30 minutes of the day. This is the only time the market isn't as impacted by these positions, and this is when it has been the MOST volatile. Perhaps removing the leveraged ETFs may create MORE volatility or more downside, as people have to put more money at risk or feel as those they have little or no downside protection, so they just outright sell.


On Apr 27 11:34 PM inthemoney wrote:

> > Leveraged ETFs came out in late '06 and really got going in '07
> and '08. Can't we think of other things that might have caused increased
> market volatility, such as issues surrounding an epoch credit crisis
> and challenge to the viability of our financial system, not to mention
> the recession that went along with it.
> ----------------------...
>
> We see 2% moves almost on daily basis in the last 30 min of trading.
> I think it is a high time somebody looked into this. If it was the
> economic situation that made the market super-volatile, it would've
> been distributed throught the day (and there is some of that) but
> the 90% is in the last 30 min.
> For anyone watching markets daily it is very very obvious. A lot
> of people can actually predict the moves, and front running them,
> thus making the move even bigger. The last 30 min move is usually
> the opposite of the move on that day, but in the direction of the
> previous day (if that was opposite). If the previous day was in the
> same direction, then the last 30 min is in the direction of the day.
>
> Now, if I can figure it out, what the Wall Street wizards with power
> tools are doing with this information, what do you think?

Apr 28 09:26 AM

[Luck-o-the-...:]

Also, doesn't it strike anyone as odd that the negative article referenced here was written by Barclays...a direct competitor to the leveraged ETF providers. One would have to assume that for every dollar invested or traded in the leveraged ETFs would be two or three dollars NOT invested in the Barclays ETFs...

Apr 28 09:31 AM

[AndrewBaker:]

I trade leveraged ETF and am wary and try to avoid holding (certainly the 3x) overnight, particularly in the current market climate where volatility is high and the market/sector/stock trendline changes so frequently and rapidly. Given this volatility and changeability, a 2x, 2.5x and 3x ETF will demonstrate higher geared price volatility by definition. Whether they cause price changes or are a result of them, I don't know, and I do appreciate the math in the full article which I've read; but everything is out there for people to use or not as they wish, and I do not agree that they should be removed from the marketplace. A good argument could be put forward that they assist liquidity, and people will concur or disagree with that, but in the final analysis, no-one has to use them if they don't want to, and no-one can yet show that they cause market problems. Take 'em or leave 'em but don't take them out.

Apr 28 10:58 AM

[squark62:]

i concur with AndrewBaker, Luck-o-the-Irish and Marc Gerstein on just about everything they said here. leveraged ETFs shouldn't be traded like normal equities or typical sector or index ETFs. leveraged ETFs are "tools", just like other derivatives markets, to mitigate or exploit volatility. as such, don't use them if you don't know how to handle them. because people don't know how to handle them DOES NOT, a priori, make them bad instruments.

Apr 28 11:49 AM