Leveraged ETF Ban Spreading Like the Flu

Recent trends in leveraged ETFs read a lot like the time-line for the swine flu. For years the public has heard warnings from people who many dismissed as crackpots that it was only a matter of time before a strain of the flu morphed into a highly contagious virus causing a pandemic. Then the swine flu strain emerged this spring, and municipalities across the country and the world finally took the threat seriously. Once one municipality put certain guidelines into effect, others were quick to follow.

There has been a similar evolution in the world of leveraged ETFs. Since the introduction of so-called triple leveraged ETFs late last year, we, along with others, have been highlighting their negatives and inefficiencies. While they are only meant to track daily price changes, many investors hold onto them for more than a day, and that's where the problems arise. The triple leveraged Financial sector ETFs from Direxion offer a perfect example. The chart below shows the YTD performance of the 3X bullish (FAS) and the 3X bearish (FAZ) ETFs through July 16th. In a period when the Financial sector is down 2%, not only is the 3x bearish ETF down, but with a decline of 88%, it is also down more than the leveraged long ETF! So even if you correctly anticipated the direction of the Financial sector at the start of the year, you would have lost your shirt if you used these ETFs to implement your strategy. Even more telling is that even though these ETFs are supposed to move in opposite directions, earlier this month both of them announced reverse splits.

click to enlarge

For months, warnings from us and others about the use of these ETFs seemed to fall on deaf ears. Even with the growing evidence that these ETFs were ineffective and a backdoor way for investors to use leverage, regulators and firms were largely silent on the issue. Finally in June, FINRA and the Massachusetts Attorney General warned that these securities were unsuitable for investors to hold for more than a day.

FINRA's warning seems to have struck a chord as several firms have begun to ban or severely curtail the ability of investors to buy and sell these securities in their accounts. In the last few weeks, we have seen outright bans or severe restrictions put in place by firms such as Edward Jones, LPL Financial, Ameriprise Financial, and most recently UBS. Now that the ball has been put in motion, investors in these ETFs should be aware that as more and more firms ban trading in them, liquidity is likely to fall, causing higher trading costs through larger bid ask spreads.

Comments

[Kanman:]

That link is a must read (granted it's by Profunds so you must accept their reporting). Having traded at Profunds 2x ETF 5 times this year I can say this from experience. Trading range was anywhere from 1 day to 6 months, and it always gave 2x return (or acceptably close). There are few ways I can think of (other than these leveraged ETFs) for an every day trader to gain this leverage.


On Jul 28 03:14 PM Missing_Link wrote:

> Hey "IHateFraud," here's your homework assignment: read this.
>
> seekingalpha.com/artic...

Jul 30 02:34 PM

[Kanman:]

What?!

How is buying an index tracking ETF paramount to gambling? You could buy a fund in the index, a vehicle that tracks the index, or and ETF that leverages the index. How the heck do you extrapolate that into gambling? By that logic, investing = gambling. Sorry, that's not correct.


On Jul 29 08:46 AM John Bowman wrote:

> Do these instruments actualy add any vaue into the economy? To me,
> they are similar to going to the casino and playing the odds.
>
> Gambling...pure and simple.

Jul 30 02:55 PM

[Kanman:]

Maybe my math is off Barclay. If you had a 2x S&P and the S&P went up, you'd have 2x the return of the S&P. And that allows me to play LOTS of golf. In fact, I had a legitimate chance at birdie on a par 5 last week. Then proceeded to three put. Ah well, back to trading ETFs.


On Jul 29 09:35 AM Barclay wrote:

> Haven't you all learned that you cannot beat the S&P? I know
> its fun to pretend you have a job but seriously, you haven't beat
> it with any regularity anyway so go golfing, spend time with your
> kids, get a real job, something.

Jul 30 03:02 PM

[Kanman:]

Good background info on ETFs via wikipedia:

en.wikipedia.org/wiki/...

Jul 30 03:24 PM

[261133:]

May I ask something. I do hold shares of SSO, because I saw this as an investment in the S&P 500. Regarding to this article and most of the posters it seems to be a bad decision.
Could someone please explain and advise .
Thanks a lot
Daniela

Jul 30 04:58 PM

[sethmcs:]

Seems to me that the only ones making money on these things is the guys who control the fund. To all those who think EFTs are great maybe I should form x36 S&P sell it to you and watch you (decay) wiped out in five minutes.

Jul 30 06:36 PM

[Kanman:]

sethmcs. That post was either a joke, or you have no idea what your talking about. Nobody can control an uderlying index... are you serious? And by the way they are Exchange Traded Funds, thus ETFs, not EFTs. If you want to sell me a 36x ETF, I'll retire in two days. Good luck to you.


On Jul 30 06:36 PM sethmcs wrote:

> Seems to me that the only ones making money on these things is the
> guys who control the fund. To all those who think EFTs are great
> maybe I should form x36 S&P sell it to you and watch you (decay)
> wiped out in five minutes.

Jul 30 06:59 PM

[sethmcs:]

@ x36 the interest and fees paid would wipe out your equity. Anyway I'll stick with equity options and stocks.

Jul 30 11:36 PM

[just.a.guy:]

It all boils down to this:

Leveraged ETFs re-lever every day, and so will have a natural drift away from the underlying based on its volatility

Volatility isn't the only concern, it's also the sequence in which it's achieved -- leveraged ETFs have a high degree of path-dependence.

Those two things make leveraged ETFs like nitroglycerine for the types of buy-and-hold fee-generating cattle that the big brokerages like to corral.

Therefore, they are unsurprisingly banning them.

Here's a good read on the details of levered ETFs and their path dependent option value: www.scribd.com/doc/144...

Jul 30 11:53 PM

[speeddaimon:]

I think that there has been some confusion in the comments of this post. After reading many of the comments it seems that some people are reading (somewhere?) that ETFs are bad or bad to hold. ETFs in themselves can be held for long periods of time. The product under scrutiny in this post are LEVERAGED ETFs which experience resetting, reverse splits, and all kinds of other things that I don't (nor do I claim to) understand thus I stay the hell away from them. There is a difference between a leveraged ETF and a regular ETF.

Jul 31 11:54 AM

[Analyste de...:]

Speeddaimon-
There has been an INTENTIONAL attempt to conflate/confuse ALL ETFs with "levereaged ETFs" because the mutual fund companies and financial advisors are losing business. (They lost a bundle of their clients' money, so they're looking for something else to blame!) FINRA also conflated INVERSED and LEVERAGED ETFs, because the market masters don't want savvy retail investors shorting the market. (Why? Because that was the only way to make $$ in the Bear Mkt!) There are very simple answers to explain the frenzied attacks on ETFs - follow the money!

There's an all-out campaign against ETFs, and "leveraged ETFs" are the Achilles Heel.


On Jul 31 11:54 AM speeddaimon wrote:

> I think that there has been some confusion in the comments of this
> post. After reading many of the comments it seems that some people
> are reading (somewhere?) that ETFs are bad or bad to hold. ETFs in
> themselves can be held for long periods of time. The product under
> scrutiny in this post are LEVERAGED ETFs which experience resetting...

Jul 31 01:11 PM

[all in:]

smartStops hit it on the head with the least amount of words,word.

Jul 31 08:11 PM

[Anthony Alfidi:]

Good riddance to leveraged ETFs. Creating indexed products that behave like hedge funds is an unnecessary innovation in finance.

Aug 01 12:52 PM

[Kanman:]

No, it's actually a way for everyday investors to have a chance to compete with the likes at Goldman Sachs. Why wouldn't you want every-dat investors to have leverage like the big boys?


On Aug 01 12:52 PM Anthony Alfidi wrote:

> Good riddance to leveraged ETFs. Creating indexed products that
> behave like hedge funds is an unnecessary innovation in finance.

Aug 03 01:28 PM

[BlockTrader:]

Absolutely responsible of you to still support these ETFs after losing so much. This is the view that those of us who trade them take: it's OUR own responsibility. I don't need washington to protect me from my trading.

I think there's somethign else going on here. Why are the people who are highlighting their "buy & hold insufficiencies" (duh, honestly...) ALSO calling for them to be banned? Do they not want to retail investor to be able to get ahead? Are they REALLY concerened about how well we all understand them or are they just trying to limit our gains?

I will also be pissed if they jerk these out of the market. I have a hard time believing that they will, though. There are currently dozens if not hundreds of application requests from State Street, Barclay's and the like for new 3X ETFs.

I'd be shocked if they actually revoked them completely. Does anyone think this actually a possibility? If some politician grabs onto it to make it look like he's doing something I'll be writing his office that day.


On Jul 28 01:20 PM Missing_Link wrote:

> Amen! Same thing here. Lost $100K on leveraged ETFs.
>
> I have no one to blame for it but myself, and BPYHO, I salute you
> for your responsible attitude.
>
> I wish the Bespoke clowns had anywhere near your level of insight
> and understanding.

Aug 06 04:15 PM

[BlockTrader:]

Anthony you're an idiot for wanting them to be banned. Why don't you ban violence and porn on TV, too? Oh I know why... because you have a choice as to whether or not to watch it! Well, trading levereged ETFs is your choice as well. Don't impose your fragile opinion on the rest of us.


On Aug 03 01:28 PM Kanman wrote:

> No, it's actually a way for everyday investors to have a chance to
> compete with the likes at Goldman Sachs. Why wouldn't you want every-dat
> investors to have leverage like the big boys?

Aug 06 04:18 PM

[BlockTrader:]

I made great money over the past week in FAS and FAZ. I usually trade in and out of them multiple times a day. I'm generally liquid cash at the end of every day. I could care less how the FAS is doing compared to the XLF year to date. If you daytraded the FAS throughout that time period you made more money than if you held the XLF - assuming you know how to trade.

Can we all just agree that the margin and maintenance requirements should be higher for these (as scottrade and the like have done) and then put up a BIG SIGN that says DON'T BUY AND HOLD THESE FOR MORE THAN A FEW DAYS. How about that? Why are all you mutual-fund buynhold' types freaking out about these to the point where you want them BANNED? Calm down, just don't buy them. After the great decline of 2008 the least the SEC can do is give people a chance to use these to make some money - as long as we all understand how they work. "RETARDS BEWARE - LEVEREGED ETFS WILL KILL YOU. DAYTRADERS WELCOME".... how about that sign? great, lets move on.


On Jul 28 12:40 PM Ryan Freund wrote:

> I can't believe how many times I've had to say this, but here it
> is again:
>
> These are not only daytrading vehicles. They're trend trading vehicles.
> If a trader believes the market will trend one way, these can work
> over days/weeks/months/years as long as the trend is solidly defined.
>
>
> Please, people, come to your senses and understand this.

Aug 06 04:27 PM

[BlockTrader:]

Can any Levereged ETF detractors please explain why a 2 hour momentum trade on a move up in financials is a bad thing to catch on FAS, for example? Pending home sales Tuesday 8/4 up 3.6%, a big move in the market and a big move up in FAS. I didn't get ripped off - I made $3,700. FAS moved up 7.09% while the XLF moved up 2.47%. This represents a 2.87x performance of the Financial SPDR. Not bad. So what if it's not exactly 3X? 2.87 is pretty close - close enough to propell my gains on that 2-3 hour trade. SO WHAT'S YOUR BEEF? ... That I sold out and made some money..... or that you missed it or are mad that you didn't get exactly 3X? Greedy or Jealous? Pick your poison.


On Jul 28 06:02 PM IHateFraud wrote:

> The PROBLEM is people expect a fair playing field when they buy a
> stock or ETF...While it's debateable whether a particular stock is
> manipulated or not, FAZ and FAS are CLEARLY MANIPLUATED on a daily
> basis...And despite traders/investors seeing this for themselves,
> they STILL throw huge amounts of cash and retirement funds at FAZ
> and FAS every day, not even suspecting (or wanting to believe) that
> it's a RIGGED GAME!!!!!!!
>
> Pick a day...ANY day and compare RIFIN's performance to FAZ and FAS
> and you don't even have to look at a YEAR's performance to conclude
> that they are RIGGED! It reminds me of the old radio game on the
> morning show called, "YOU CAN'T WIN!" After years and dozens of people
> calling up and LOSING, they still called! Even though they always
> asked each player, "OK...Are you ready to play YOU CAN'T WIN?!" They
> always said, "Yes!" (As a side note, I think they finally did let
> someone win)...
>
> Take today. According to Yahoo Finance, RIFIN was DOWN 0.33%
>
> So if you have to hold for "an entire year" to lose with FAZ and
> FAS, then FAZ would've been UP 0.99% today and FAS would've been
> DOWN 0.99%...Problem is:
>
> FAZ was only UP 0.81% today and FAS was DOWN 1.14%...Now for those
> who say, "Yeah, but it's just so difficult if not downright impossible
> to be up and down EXACTLY 3X on any given day..." I say, "Funny how,
> no matter which one you BUY, you always GET less than 3X when you're
> right on trend and you get socked with a hit of MORE than 3X when
> you're wrong."
>
> Now I can show example after example after example of these types
> of inequities on a Daily, Weekly, Monthly or Annual basis -- Yet
> STILL there are those who not only FLOCK to these "When Direxion
> wins, Direxion gets MORE...When I win, I get LESS" absolute obvious
> SCAMS...But they CRY, "Please don't take these away from me because
> I know how to use them correctly." It would be LOL if it were not
> completely pathetic.
>
> Understand this: Stocks are supposed to go up and down based on "buying
> and selling pressure"...That's what we've all been taught. There
> is absolutely NO REASON that FAZ and FAS can't produce prices that
> move EXACTLY +3X and -3X every single day...But that would mean Direxion
> would have to assume some of the RISK of these instruments that is
> currently 100% shouldered by the BUYERS of these "ETF"s. The actual
> buying and selling of FAZ and FAS have NO EFFECT on their pricing.
> And therein lies the SCAM...Read this paragraph again if you still
> don't "get it"...
>
> IF, and I emphasize IF, FAZ and FAS did move +3X and -3X daily in
> relation to RIFIN (and AS ADVERTISED), then I would have no problem
> at all with them. But when you're right and you get less than +3X
> and when you're wrong you get taken for more than -3X...Then you
> are PLAYING A LOSING GAME no matter what time frame you convince
> yourself you are good enough to win at.
>
> FAZ and FAS will rarely (IF EVER) exactly produce DAILY price moves
> that correspond to the advertised +3X and -3X performances that are
> easy enough to produce -- Just set the CLOSING PRICES equal to a
> +3X and -3X move of RIFIN...(This is possible because Bid & Ask
> or even Size doesn't move the price in these vehicles.) This FAILURE
> TO ACHIEVE is a direct contradiction to the stated objective of the
> "ETF", and IMHO proves an INTENT TO DECEIVE.
>
> But if Direxion were ever FORCED to do this and truly level the playing
> field and deliver on their +3X and -3X "promise", they would shut
> FAZ and FAS down the very next day because they would be back to
> settling for the spread for profit...As it is now, they MAKE HUGE
> PROFITS EVERY SINGLE DAY and every single time someone buys one of
> these scams because they are plain and simple vehicles of MANIPULATION
> designed to go to ZERO value until a reverse split sucks in more
> suckers.
>
> If you still think FAZ and FAS are "good trading vehicles" that you
> just "cannot live without", then please take all of your money out
> of the market and put it in a boring savings account or home safe.
> When you go to get it, it will still be there. Otherwise, Direxion
> will use their tilted table to eventually bankrupt you through FAZ
> or FAS...It doesn't matter to them WHICH one you buy and for how
> long you hold it each time you buy it...You'll LOSE!
>
> "The decay is MINIMAL unless you hold it for well over a week. Of
> COURSE they're sucker bets if you hold them an entire year. We've
> already gone over this many times. It's irrelevant to traders who
> know that you're not supposed to hold them for anywhere near that
> length of time. Their performance over an entire year proves NOTHING
> about the ETFs themselves.

Aug 06 10:18 PM

[BlockTrader:]

you're an idiot. don't buy and hold these ETFs. Trade them over a few days, hours or minutes. Don't like that concept? Don't do it then! Use the XLF! WHINERS! Why ban them? You all sound like an angry mob with torches. Burn the witch!


On Jul 28 03:04 PM IHateFraud wrote:

> CORRECT! The fact that you have to SHORT both FAZ and FAS in order
> to make money long-term, when they are SUPPOSED to be INVERSES of
> each other PROVES ONE THING:
>
> THEY ARE FRAUD VEHICLES, DESIGNED TO DEFRAUD ANYONE WHO BUYS THEM...PERIOD.
>
>
> They attract those who are sucked in by the promise of 3X the movement
> when they're right on trend, but they NEVER DELIVER. And when trend
> moves against them, they suffer MORE than a 3X DECLINE...And those
> are just DAILY PERFORMANCES.
>
> So how can anyone claim they "know how to correctly use" FAZ and
> FAS when you ALWAYS get less than you should when you're right and
> you PAY MORE than you should when you're wrong??? .
>
> Do the research...Count how many DAYS FAZ and FAS each ACHIEVED either
> > or = 3X movement of RIFIN when correct and suffered > or = 3X LOSSES
> when incorrect...Then your eyes will be MAGICALLY OPENED.

Aug 07 08:21 AM

[fabmarch53:]

Well, some IDIOT SOCIALIST in Washington has put pressure
to forbid those securities. They will tell you how to invest YOUR
MONEY, and only BIG FISH will be able to get some exposure
to the profits (and risks) of short-selling and options. All this is
very nasty, you should read the prospectus before investing,
and understand this is not for everyone. Wells Fargo has forbidden
on-line trading this securities today, but America will loose its
financial edge and economic freedom. I'm a foreign investor and
will take MY MONEY overseas. Sorry, my very dear American
Friends !!! You are loosing your freedom !! Be alert !!
Fabrizio.


On Jul 28 12:12 PM BPYHO wrote:

> As a person who has lost about 4k from these I have to say - it's
> my own damn fault. I didnt pay attention to the warnings back in
> March when I first started buying them. However, now that I know
> the correct way to use them, I love them and would be VERY disappointed
> if some idiot in Washington tried to limit their availibility...

Aug 14 06:45 PM