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FAZ and FAS are the Direxion Daily Financial 3X Bear and Bull ETFs. With their enormous leverage, they have become more popular, I think, than anyone would have expected. On Monday, July 26, they traded 49 million and 42 million shares respectively, enough to rank them as 34 and 22 in dollar volume. As you can see from the chart, they mirror each other nicely.


FAZ Direxion Daily Financial Bear 3X Shares $13.61 -4.6% vol=48.8M From-Open=-4.4% [BGYQMNZSF]
FAS Direxion Daily Financial Bull 3X Shares $22.94 +4.4% vol=42.0M From-Open=+4.1% [BGYQMNZSF]

Last year, it became obvious that leveraged derivataves such as the 2X and 3X ETFs could cause such large quantities of stock to be purchased and sold during background hedging of the ETF that the ETFs were moving the market disproportionately. The tail, so to speak, had gotten so big that now it was wagging the dog. To prevent excessive speculation, margin requirements were raised on the ultra funds to 67-100% for most trading firms, effectively preventing ordinary investors from making full use of the fund's leverage. For instance, the investor is more leveraged buying 4x the account equity of IYF on margin to daytrade than buying 1X of the account equity in the 3X FAS. The change in margin requirements had little effect on options, however, and within a short time of their inception every one of the original 21 Direxion 3X funds had option chains trading. (New funds bring the total to 37; a few new ETFs are not optionable yet.) Options on leveraged funds are wild, volatile, fast moving positions. Investors love them.

Monday's bullish move in the overall market caused a lot of money to be made and lost in the FAZ and FAS options. Since the two ETF's are mirror images of each other, you might expect their options to behave in a symmetrical manner as well, but here's the secret: they don't. Let's take a look at the effect of Monday's market rise on the FAS calls and the FAZ puts.

First, you can see that the bullish move in market financials could be played with a put on FAZ or a call on FAS. The peak appreciation was in the FAZ Jul 30 $14 Put, at 89%; second was the FAS July 30 24 call at 75%. This is generally true - the potential return on FAZ puts, in a rising market, tend to be higher than the return on FAS calls. I attribute this to investor psychology; it is more intuitive to go long the bull than to go short the bear. Note that in a falling market, theory says the reverse should be true - with the advantage in puts on FAS rather than calls on FAZ - but my observations seem to point to more symmetry in that case.

The chart shows extra appreciation in the "cheap" end of the August and September FAZ puts, particularly at the $11 strike. This represents investors taking positions intended to pay off if the market move becomes extended. You would expect to see the "tilt" in the August and September FAZ puts, up on the cheap side, to be mirrored by a rise in the FAS calls on the cheap side. But the plots of the August and September FAS calls are almost flat. This, I believe, is explained by the volatility depreciation of the two funds, the fact that each fund's price degrades over time due to leverage expenses. Depreciation means that the put side is always somewhat favored.

It's hard to say to what extent these effects are driven by investor psychology. Depreciation is a small effect, and we can argue that its mere existence causes investors to over-avoid the call side, thereby raising the appreciation on the put side. The exact mechanism would make a good topic for someone's PhD dissertation, but we needn't dwell on the actual cause. "Why" isn't important; just knowing "what" is enough.

Disclosure: No positions

Source: Trading Options on FAZ and FAS