Daniel Moser

Leveraged ETFs Might Be the Cause of Late Day Trading Moves

This late in the day momentum argument is structurally sound. The leveraged ETF's are mandated to maintain a 2:1 debt to equity ratio or in some cases even a 3:1. When the general market gets extremely volatile it throws their debt to equities ratio off drastically on a daily basis, thus they have to go out into the market place and buy or sell their underlying securities to rebalance their debt to equity. Remember they don't care where the market is going...there job is to be 2:1 Long or Short their underlying index.

Now, why would this occur at the end of the trading day? Easy...if your job was to maintain a 2:1 debt to equity position, you would never rebalance at 12:00 during the day. You would have no idea what your portfolio would look like at 3:00. Thus, they have to wait until the end of the day so that they actually accomplish their mandate.

Also the argument that they don't actually buy or sell underlying stock is fundamentally not true. You can easily see their top 10 holdings in many of them. Think about it...how do you maintain a 2:1 leveraged ratio on some set index? You issue a bunch of debt and buy all the underlying securities. When your debt to equity gets out of whack because of the change in stocks prices, it is by far easier to buy or sell equities than it is to alter your debt structure. If for some reason I am wrong about this argument, my next point would be that somewhere with in mere seconds a market maker is out there shorting or buying stocks so that they are hedged thus somebody is trading the underlying stocks.

I don't really believe the VIX has anything to do with this at all except to the extent it can predict volatility in the coming month. This is all about the mandates of the ETF's that force momemtum to beget more momentum. It takes violent market moves to force these ETF's to rebalance in big ways which just makes the market move even further. If the actual volatility dies down...their rebalancing won't be so disruptive.