Using the Direxion 3X Daily ETFs, All 22 of Them

The 3X funds from Direxion have grown to 22 in number. These 3X funds have been widely disparaged, because they have been used as longer-term holds by investors who did not realize that the funds are designed to depreciate (in proportion to the volatility of the price) a bit every night. The funds only have low depreciation when they do not change much in price. However, as a convenient hedge in a daytraded pairs play, they are perfect because they require relatively little capital to establish a position. This is how they were designed to be used. For instance, if during the morning opening, you think that Research in Motion (RIMM) will move up in price, you might buy some RIMM and some TYP, the Technology Bear, and hold both through the trading day. If technology shares sink, taking RIMM down with them, you would be hedged by owning TYP, which would rise. But if RIMM behaved as you suspected, and rose faster than technology in general, you could sell them both at the end of the day with a profit.

Because the funds reset and depreciate overnight, they are not a good choice for an overnight hold unless you feel that the potential for a large move, with the high leverage the 3x fund gives you, outweighs the cost. This can be partly offset by using short positions instead of long ones. For instance, in the previous example, instead of going long TYP the Technology Bear, you can go short TYH the Technology Bull. In doing so, the depreciation will tend to work to your advantage for the overnight position. Shortable shares for these funds are sometimes hard to find, or require a shorting fee from your broker. This tends to partly offset the potential gain of going short a bull and bear fund both and trying to design a pairs trade to profit from the depreciation. (a strategy which CAN pay off if you do your math - I may write an article on how to set this up later...)

But the ultimate example of unbridled, extreme, red hot firepower in trading these funds has to be playing them with options. Every one of the Direxion funds is optionable! Buying a deep-in-the-money call or put on one of the funds gives you a minimum of premium, a maximum of intrinsic value, and a leverage which is enormous. It is having a tiger by the tail. Give it a try, but be very, very cautious. -- by Skymist

Comments

[HomeEconomics:]

I'm scaling into puts on as many of these long 3X's as possible. I've found no reason to ever own calls as most of these ETFs are on a long journey to zero.

DRN is probably the best play if you have the capital to get some ATM puts.

Oct 14 11:13 PM

[GoochyPuppy:]

The leverage is really convenient, especially on the short ETFs.

Oct 14 11:56 PM

[marketstudent:]

So many people don't understand simple arithmetic. TNA has gone from 10.21 in March to over 50 in September, which is a 400% increase. Please, short TNA! Give me your money! Now I'm looking more at EDC, DZK, and MWJ.

Oct 15 09:45 PM

[HomeEconomics:]

Shorting any of these directly is a fool's move.

Like the poster said, "Buying a deep-in-the-money call or put on one of the funds gives you a minimum of premium, a maximum of intrinsic value, and a leverage which is enormous."

Shorting and having to cover margin on a whipsaw at 3x is asking for trouble.

Still, anyone holding these ETFs long for an extended period is going to get burned.

On Oct 15 09:45 PM marketstudent wrote:

> So many people don't understand simple arithmetic. TNA has gone
> from 10.21 in March to over 50 in September, which is a 400% increase.
> Please, short TNA! Give me your money! Now I'm looking more at
> EDC, DZK, and MWJ.

Oct 16 04:47 PM

[marketstudent:]

If making a 400% profit in 6 months is getting burned, may we all get burned!


On Oct 16 04:47 PM HomeEconomics wrote:

> Shorting any of these directly is a fool's move.
>
> Like the poster said, "Buying a deep-in-the-money call or put on
> one of the funds gives you a minimum of premium, a maximum of intrinsic
> value, and a leverage which is enormous."
>
> Shorting and having to cover margin on a whipsaw at 3x is asking
> for trouble.
>
> Still, anyone holding these ETFs long for an extended period is going
> to get burned.
>
> On Oct 15 09:45 PM marketstudent wrote:

Oct 17 09:34 AM

[oghowie:]

I'm new to the concept of ETFs, so I have a question.

If I believe DRN will perform in the next month or so is there any disadvantages to holding it for a few months, or would it just be better to buy individual stocks. I'm willing to accept the volatility involved because of the potential higher returns.

Is my thinking flawed?

Oct 19 01:25 PM

[redwine44:]

I am confused by one thing the author said, I would appreciate some help/explanation. "The funds are designed to depreciate a bit overnight", in proportion to their volatility. I don't get it. Other than the expenses which are legally published, what depreciation are you referring to? I know that the prices supposedly reset each day. But that is not different than stocks, is it, which can open the next day at a price very different than the prev. day close? The ETF price on the new day is set based on the underlying index, which is the sum of the items in the index, no?

Would appreciate any/all answers, thanks.

Oct 20 11:30 AM

[SDTrader:]

Hi MyHT.

I am interested in your views on shorting both long and short leveraged ETFs. I am currently short both FAZ and FAS in equal dollar amounts, and so far am up 6% in one month. As the trade "in theory" seems to be a free lunch due to decay of both, I would like to make sure I am not missing something important or have overlooked risks. I have a solid relationship with the bank I am doing this so I have no problem in shorting these two pairs.

Thank you.

Oct 21 06:42 PM

[Skymist:]

I'll be glad to explain. The funds are advertised as following the "daily" performance of a specified index, times 3. That means, for instance, if IYF the financial fund is up 1% at the end of the day, then FAS should be up 3%. And indeed, it usually is. But what happens overnight? The change in value of the FAS fund, as a whole, forces the fund backers to either create or destroy (cash in) shares in the fund. To do that, their counterparties will either create new swaps (contracts) or cash in old ones. Doing so creates fees and commissions. Only whatever money is left over is available to create new shares or prop up FAS as a whole. So FAS gradually loses a bit of value aside from the underlying index. The only time FAS does not lose value is when the total value of FAS, and the total number of shares of FAS remain exactly the same one day as the previous day. Then, no swaps have to be cashed in or created, no sales happen, and no extra expenses are incurred which have to be billed to the fund. But such days are few.

Compare that to a "closed" fund. This kind of fund issues a limited number of shares, and once issued, the number of shares never changes. If you buy a share, you are buying it from another shareholder, always. You and that shareholder pay a small commission to your brokers but that comes from your account, not the value of the share.

In general, the higher the "multiple" of the non-closed fund, the greater the overnight depreciation. A 3X fund is worse than a 2X fund. There is talk of a 4x fund, which would be worst of all.

If you are tired of "shrinking" funds, and would like to trade or invest long term in a closed fund, some of the best are the Blackrock funds. Many are publicly traded. Closed funds are generally either invested in debt or equity. You can buy shares and not worry as much about expenses, which are small. For a fine Blackrock closed-end high dividend equity fund, check out BOE. For a
similar high dividend debt fund, look at BDJ. They are real investments, not flaky trading tools like FAS and the other "leverage funds."

-- Skymist
On Oct 20 11:30 AM redwine44 wrote:

> I am confused by one thing the author said, I would appreciate some
> help/explanation. "The funds are designed to depreciate a bit overnight",
> in proportion to their volatility. I don't get it. Other than the
> expenses which are legally published, what depreciation are you referring
> to? I know that the prices supposedly reset each day. But that
> is not different than stocks, is it, which can open the next day
> at a price very different than the prev. day close? The ETF price
> on the new day is set based on the underlying index, which is the
> sum of the items in the index, no?
>
> Would appreciate any/all answers, thanks.

Oct 21 07:23 PM

[Skymist:]

You will need to peruse your account statement. You will probably find charges accumulating there for "hard to borrow" charges, or "threshold rates" or some other such fees related to holding the shares short. These fees will reduce or eliminate the gain you get from going short these shares. The only way to see how much money you are making is to add in those fees. If they are small compared to the fund depreciation, then you make money, but if they are large, you lose.

-- Skymist


On Oct 21 06:42 PM SDTrader wrote:

> Hi MyHT.
>
> I am interested in your views on shorting both long and short leveraged
> ETFs. I am currently short both FAZ and FAS in equal dollar amounts,
> and so far am up 6% in one month. As the trade "in theory" seems
> to be a free lunch due to decay of both, I would like to make sure
> I am not missing something important or have overlooked risks. I
> have a solid relationship with the bank I am doing this so I have
> no problem in shorting these two pairs.
>
> Thank you.

Oct 21 08:40 PM

[Skymist:]

In most cases it is better to hold the individual stocks. Remember that an ETF is an average of stocks, some going up and some down. If you can pick a better stock than the ETF average, you do better.

The second way you do better with individual stocks is due to margin. If you buy IBM and hold it in a margin account, your broker will only require 25% down. But most brokers now disallow margin for the 3X ETF's. That means, the margin requirement is 100%. You need 4 times as much money to hold a 3X fund in your account as you would for a stock worth the same amount. If the stock goes up 1%, the ETF will go up 3%, but you own 4x as much of the stock as the ETF, so the one which makes the most money for you is the stock, not the ETF. Unless the stock you picked is much worse than the average stock...

-- Skymist


On Oct 19 01:25 PM oghowie wrote:
> If I believe DRN will perform in the next month or so is there any
> disadvantages to holding it for a few months, or would it just be
> better to buy individual stocks. I'm willing to accept the volatility
> involved because of the potential higher returns.
> Is my thinking flawed?

Oct 21 08:52 PM

[HomeEconomics:]

How's that 400% profit looking now?

My puts on FAS are growing by the day... I win even if the market keeps going sideways. FAS down from the 90's to the 60's in a matter of a week.


On Oct 17 09:34 AM marketstudent wrote:

> If making a 400% profit in 6 months is getting burned, may we all
> get burned!

Oct 30 06:21 PM

[frorule21:]

The decay does not necessarily occur overnight. It is due to the 3x (or 2x) leverage, and the simple fact that 10% up is not the same as 10% down.

If a 3x fund takes a 20% hit one day, it would take a 25% gain just to get back to even. The market would constantly have to trend upward just for a leveraged fund to remain flat.

Nov 02 10:54 PM

[Superdrol:]

Hi Skysmist,


Could you please go into more detail how you could short the 3x leveraged ETF mathematically so that you could use it to your advantage as you stated earlier in the article ? Thanks again for your time and writing the article !

Nov 10 08:10 AM

[jrocean:]

Could someone please explain how EDC droppped from 148 to 127 at pre-market open, whereas EDZ was up only 30c from 5.59 to 5.89?

Also, EDZ quickly closed the opening gap, whereas EDC has stayed roughly unchanged.

What am I missing?

Nov 20 10:36 AM

[Jeff@WMD:]

jrocean:
Today is ex-dividend for several leverage funds. That's why they are way down.

Nov 20 01:17 PM

[Jeff@WMD:]

In response to the comment asking about the double shorting strategy briefly mentioned in the post, let me make a few comments.

I've been using the strategy for several months. I researched the idea for several weeks before I put it into play. I read everything I could find about it (which was not much, but there's probably more out there now), found a few academic articles that were helpful, plowed through the math, determined the best funds to use, ran backtesting, and basically analyzed it to death. My implementation is much different than it would have been without analyzing it to death.

The strategy does well when there is high volatility without a strong upward or downward trend. The strategy likes reversion to the mean. Pick the highest leveraged funds (3x) with the highest volatility. For example FAS/FAZ is a much better pair than a 2x fund with low volatility.

I don't rebalance. Rebalancing defeats the purpose of the strategy. However I can see someone carrying out the strategy in a slightly different way than me that would use rebalancing.

When tracking performance, make sure you take into account two costs: 1) "hard to borrow" costs imposed by your broker, and 2) "in lieu of dividend" payments. The "hard to borrow" costs can be significant, but they have come way down the last few months with my broker. The "in lieu of dividend" payments don't necessarily hurt you, because they are accompanied by drops in the share price. Just be aware you need money on hand to pay the dividends. They can be large. Some funds had dividends today equal to 15% of the NAV. Amazing.

Oh and be aware of the taxation of the "in lieu of dividend" payments. The taxation is not complicated but it works differently than you might expect. Depending on your tax situation, you may be able to use it your advantage by turning "capital loss" into "investment expense." Pretty cool. It works for non-leverage funds too by the way, but more fun with leverage funds because of the crazy high dividends.

Nov 20 07:46 PM

[aspiring_be...:]

I have several questions which I wonder if the experts (i.e. Skymist, Jeff, etc or others) could give me some guidance on.

Background: I bought 50 shares of TZA midday on October 9, 2009. Price at execution was $11.60. The Russell 2000 (which it is based on) midday was approximately 583. For the purpose of my questions, we don't have to go out to the last decimal point, it won't change the nature of the questions much.

This purchase was my first foray back into the market since the 2001-2002 period. Back then, I made a profit on 7 of the 8 stocks I bought (long), in a generally down market. Just giving my background and history, for context.

Like Jeff, above, I studied TZA for well over a month before buying it. Paraphrasing Jeff, I studied it back, forth, and sideways. I feel that I understand most of the characteristics of it very well (and certainly better than 90% of the retail investors who might buy it). I understand the compounding, "path dependency" (I think), the variance from the index it tracks, the "slow bleed" over time of holding it too long, and the overnight reset. I have not read the prospectus (who could?) :)

I did so many percentage calculations and studied so many graphs, that my eyes glazed over. I've probably spent well over 50 hours studying TZA alone, and at least another 50 studying the Russell 2000 and leveraged and inverse ETF's in general.

I have been very happy with how the TZA has (or hasn't) mirrored the theoretical inverse 300% gain (even though I'm close to flat at the moment). I have held this purchase much longer than most people would recommend. I understand that. It's true that there has been some "slippage" in how well it has matched over the approximately 41 calendar days I have held it. I should probably sell it and rebuy it back a day or two later, at this point. I am using it because I have a belief that the overall market, and the Russell 2000 in particular, are going to experience a good size downturn in the very near term.

I have that feeling that we've all had at some point I suppose, where the two days after I sell it would be the two big "crash days" (or the other way around, for somebody who was short in something, non-inverse---you know what I mean...).

Here are some observations I've made regarding the "tracking accuracy". First, in appx the October 9 to November 2 timeframe, the Russell went down by 9.2% and TZA went up 23.5%. If the mirroring were exactly correct, and there were no overnight resets and other variances, then the TZA would have been up 27.6%. But speaking just for myself, I am not concerned about the difference between the two numbers. I knew going in that this inaccuracy was inherent in the nature of what TZA is. If I had cashed out my position on November 2 and made 23.5% in three weeks, I could live with that very easily and happily, even though I would have missed a few percentage points. The leverage blows away the error. So if my gain were 85% of 3x, instead of 100% of 3x, that's cool.

So with all of that background, here are my questions. I apologize ahead of time if my questions seem ignorant. I've tried to research them on my own but just haven't found the answers yet.

1. I have seen several references in various articles about "dividends" or "distribution", particularly regarding taxes. Can anybody point me to a place where I can learn more about that? One of the postings above referred to this past Friday (Nov 20) being a "distribution day" for some ETF's being discussed in this thread. Does this "distribution" somehow increase (or decrease) the value of each share of TZA? Otherwise, how does this "distribution" or "dividend" affect the price, or the value, of the ETF? If a person who holds an ETF such as EDC, mentioned above, does the person owning it benefit somehow? If not, that would seem weird, because as jrocean points out above, his EDC gapped dramatically down overnight. Does jroceans' ownership position, and the change in value of a share of EDC from 148 to 127 just "disappear"?

Where, or to who, does this "dividend" or "distribution" go?

Do I eventually receive a "check" in the mail if I owned EDC? (my account is in street name). Does my brokerage know that I own the shares going into the "dividend" date, and somehow I get paid from that?

2. When I buy TZA, who am I buying it from? I know this might sound like an absurd question, but if you think about it, the question makes sense (at least to those of us who don't know the answer). If I were to buy a share of Ford, I know I am buying it from somebody else who owns it (or from a Market Maker or a Floor Specialist or through SOES or whatever), all of which are pretty much the same, they all are buying a share that somebody else is selling, and the price floats in supply and demand from moment to moment).

But if I buy a share of TZA, does that mean I'm buying it from Joe Schmoe who has a Sell order in? If that were so, how would Direxion make the price match the inverse of the Russell 2000? OR, am I, in some convoluted way, buying it FROM Direxion? Are THEY always the counterparty to a retail buyer or seller? I know that from minute to minute TZA does not exactly match the 3x inverse, but if you track a chart through just about any given day you'll see that most of the time it is very, very close. But it does sometimes take a few minutes or maybe even a little longer, say half an hour, to get back on track. Is this because all day long the traders or the computer programs at Direxion are doing all the complicated transactions from minute to minute involving swaps, futures, or whatever other weird derivitaves they use to maintain the tracking, hence the share value? I don't understand the conflict between the Supply/Demand principle versus what seems to be some kind of "forcing" the price to match the level of the underlying index. Or am I somehow overthinking this? What am I missing?

3. Back to the subject of "dividends" or "distributions". In one of the postings above, jeff answer's jrocean's question about ETC and EDC by referring to Fridays' price as being "ex-dividend".

I happened to have looked at TNA (3x Bull Russell 2000) on Thursday and Friday. I was watching the ticker Friday morning and TNA gapped down from a close Thursday of around $40 to a Friday opening of around $35. I thought that was weird, so I looked at RUT (the Russell 2000), and it had barely moved. I spent a couple hours doing arithmetic and calculating percentages and finally concluded that I had no idea of an explanation, and couldn't find one. I took a wild guess and thought maybe it had to do with Friday being an Options Expiration day. Anybody have an explanation? ( I guess this is basically the same as question #1). TNA and TZA are exact opposites of each other, one being a 3X Bull and the other being a Bear, both based on the Russell 2000 (RUT)

The TZA closed up .49% on Friday, virtually a perfect inverse 3X match to the Russell. The Russell was down .17%.

But TNA closed down 11.8%, and it is a 3X Bull, so I would have expected it to loose about .49%.

4. Regarding path dependency.....Am I correct in understanding that for a 3x leverage product like TZA, that the MORE DAYS and MORE PRICE MOVEMENT in a consistent direction, then the better the price of the ETF will do in meeting the "target" goal of the ETF, as opposed to a more "wandering" path ending up at the same place? ---for example, if the index oscillates in equal daily steps up and down 2% for five consecutive days, and then on the 6th and 7th day it goes down 10% each of those two days, the price performance of the ETF would not be as good as if it made 7 straight days down but still ending at the same index number, correct? So, in a strongly prevailing down market over a few weeks, then a leveraged ETF like TZA should do better than if there were a "drifting market" with only a day or two that took the index down to the same ending number, right?

5. I think I read someplace that Direxion had recently changed the target goal of some of these 3X funds from DAILY to MONTHLY matching of the index. What impact, if any, is this likely to have on the tracking accuracy, and also on the "bleed" over time? Does this change mean that the tracking accuracy and/or volatility will be "worse" from day to day, but "better" over a few weeks? Or the other way around?

Thanks much to anybody that can guide me on these subjects.
And again, I apologize if my questions seem simplistic.

-douglas (aspiring_beginner)

Nov 22 06:12 PM