Best-Buy Leveraged Long ETFs Now, By Intelligent Behavioral Analysis Of Market-Makers

by: Peter F. Way, CFA

Each month we have been presenting the coming price range expectations of market-makers for 40-plus actively-traded ETFs structured to provide leveraged price gains, using our systematic daily analysis of their hedging behavior. The history of such forecasts has proven prescient for many ETFs of this type.

Market-Makers [MMs] hate risk, but have to expose their firm's capital to it to get their bread and butter trades done for the big-money fund clients. So they hedge their exposures against unwanted price moves. On thousands of trades every day, on hundreds of stocks, ETFs, REITs, indexes.

What they will spend, and how they structure each hedge, tells just how far they think prices may go. Going in both up and down directions, but usually not by symmetrical odds or by equal amounts. Spending what could be profits to put in their pockets, they are extremely parsimonious, buying enough protection, but never extravagantly.

Those expectations are then compared against similar previous forecasts over the past 5 years, produced in the same manner, to see how effective their earlier insights were.

We then rank them as to desirability as buys, on the basis of their current reward prospects in comparison to drawdown risk experiences and consistency of profit-winning commitments, under similar forecast circumstances. Here are the results as of Friday, December 27, 2013:

Click to enlarge

To explain the table's column heads: Sell targets are the % rise from price now to top of the forecast range. Drawdowns average the worst end-of-day price comparison with forecast day price during each position holding among all similar Range Index experiences in the sample. The Range Index measures that % of the forecast range lying below the current price. Win Odds are the % of forecasts reaching targets, plus those that don't but, 3 months later, are at a higher price than at time of forecast. Payoffs are the average % price changes from all similar prior forecasts. Market days held reflect early closeouts of achieved sell targets. Annual rates recognize 252-market-day years. Sample size counts number of all forecast days available in the past 5 years, and the number of days therein with similar Range Indexes.

The top eleven have been screened out of more than three times as many leveraged long ETFs followed on a daily basis. Requirements are that we have a sufficient number of histories of forecasts similar to today's, where a standard time-efficient strategy has produced profits in at least 8 out of every 10 commitments. The intent is to identify those securities where MMs have demonstrated productive insights into likely future price behavior.

At the bottom of the table are averages for the group and parallel data on SPY, a proxy for overall market (S&P500) price change expectations. The blue table row averages indicate the difference offered by issue selectivity as seen by market-makers in the past, compared to the group averages and the overall market.

There is no guarantee that future prices will be similar to the past, but humans often formulate habits that are repetitive where surroundings seem familiar, and humans move market prices.

The most attractive half-dozen, based on a comparison of their upside potential to the past worst-case price drawdowns, have been highlighted in blue in the table. They are:

ProShares Ultra QQQ (NYSEARCA:QLD), a (2x) leveraged tracker of the NASDAQ-100 index, the NDX.

Direxion Daily Energy Bull 3x Shares (NYSEARCA:ERX), designed to follow the S&P Energy Select Sector Index.

Direxion Daily S&P500 Bull 3x Shares (NYSEARCA:SPXL), a leveraged tracker of the S&P500 Index.

ProShares Ultra MSCI Emerging Markets (NYSEARCA:EET), a (2x) leveraged tracking ETF of the MSCI Emerging Markets Index.

Direxion Daily Financial Bull 3x Shares (NYSEARCA:FAS), designed to follow the Russell 1000 Financial Services Index.

ProShares Ultra Pro S&P500 (NYSEARCA:UPRO), a (3x) leveraged tracker of the S&P500 Index.

Readers are encouraged to do their own due diligence on the above names. This analysis is intended to provide help on suitability in timing decisions regarding preference choices between similar investment alternatives in the active process of wealth-building. It is not an in-depth discussion of all relevant factors relating to long-term values.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.