Enjoy Risk? Then you may like 300% Leveraged ETFs

November 14, 2008 9:10 PM

Enjoy Risk? Then you may like 300% Leveraged ETFs

ETFs (Exchange Traded Funds) trade just like stocks, but may (and often do) employ leverage to obtain the desired investment objective. These particular offerings (less than two weeks old ) are summed up well here. I especially like

"if you like to go skydiving, keep a pet alligator in the bathtub, and dream of a winter king crab fishing in the Bering Strait, then you will be right at home with the Direxion ETFs."

posted by Rafaelloello (31 comments total)

I don't know what I did wrong, but before cortex deletes it, this was supposed to be my lead
posted by Rafaelloello at 9:13 PM on November 14, 2008

Hahaha. That's just what we need.

You know the whole idea of a stockmarket is that it's an system that efficiently allows people to invest in productive enterprise, therefore allowing new wealth to be created from existing wealth.

But now it seems like a pit of scavengers fighting over the remains of rapidly decaying corpse, or something.
posted by delmoi at 9:18 PM on November 14, 2008 [5 favorites]

Despite the mistakes. I was tempted.
posted by ktrey at 9:20 PM on November 14, 2008

I was expecting this to be a joke post, when it was nothing but [more inside].
posted by paisley henosis at 9:23 PM on November 14, 2008

[more inside] has never been more teasing.
posted by nola at 9:29 PM on November 14, 2008 [1 favorite]

You know, to be honest it feels like there's [less inside].
posted by Bromius at 9:35 PM on November 14, 2008

I just had to click on this.
posted by baphomet at 9:39 PM on November 14, 2008

BPPs (Blank Page Posts) look just like posts, but may (and often do) employ curiosity to obtain the desired investment objective. These particular offerings (less than two weeks old) are summed up well here. I especially like

"if you like to go extreme netsurfing, keep a pet lolcat in the bathtub, and dream of bean counting in the Big Blue, then you will be right at home with the Filterbrand BPPs.
posted by iamkimiam at 9:51 PM on November 14, 2008 [3 favorites]

I see what you did there...
posted by schyler523 at 10:03 PM on November 14, 2008 [1 favorite]

[nothing outside]
posted by Effigy2000 at 10:29 PM on November 14, 2008 [2 favorites]

Just because it makes mathematical sense doesn't mean it has any actual connotation of wealth.
posted by Burhanistan at 10:47 PM on November 14, 2008 [2 favorites]

It's exactly this type of sane and conservative approach to participation in the financial markets that will help to steer economies back to stability.
posted by longsleeves at 11:06 PM on November 14, 2008 [2 favorites]

I'd vote delete this post saving [more inside] for some really special post.
posted by jeffburdges at 11:09 PM on November 14, 2008

Can anyone state how these funds actually work? I don't give a shit that they are ETFs or OTCs, but how are they pulling 3x reliably? Does the day trading even remotely match 3x?
posted by jeffburdges at 11:13 PM on November 14, 2008

[more inside]
posted by Effigy2000 at 11:43 PM on November 14, 2008 [4 favorites]

Just when I thought derivatives couldn't get more insane.

If you trade in this, your portfolio will soon look exactly like the front-page part of this post.
posted by DreamerFi at 12:04 AM on November 15, 2008 [2 favorites]

Well, sure it seems like brutally leveraged derivatives are risky... but that's only if you're some poxy nobody who doesn't get to raid the public purse when they bugger it all up.
posted by pompomtom at 12:41 AM on November 15, 2008 [1 favorite]

jeffburdges, I imagine they borrow money and buy $3 of the underlying securities for every $1 in shares they sell.
posted by ryanrs at 1:13 AM on November 15, 2008

Um, E-Mini S&P futures trade at x50 leverage. Even the alligator is too scared to stay in your bathtub.

ryanrs, no that's not how they work. They buy and sell levered products like credit default swaps, options, swaptions, futures etc. They are managed with the help of a computer algorithm that tries to ensure, but cannot guarantee, 300% the daily performance of the underlying. Over longer terms, the performance will not match.

Bottom line, these things are trading vehicles, not investments.
posted by fatllama at 2:02 AM on November 15, 2008 [1 favorite]

Fatllama's right. From the prospectus [PDF]:

Each Bull and Bear Fund invests significantly in swap agreements, forward contracts, reverse repurchase agreements, options, including futures contracts, options on futures contracts and financial instruments such as options on securities and stock indices options, and caps, floors and collars.

posted by ryanrs at 3:00 AM on November 15, 2008

So there is actually some advantage for the ETF company to using the 3x leverage, as it lets them dick around with derivatives/borrowing, but what's the incentive to the purchaser of the ETF, what does it get them over buying 3x an unleveraged index fund? Is it just 1/3 the trading fees?
posted by blasdelf at 3:19 AM on November 15, 2008

what does it get them over buying 3x an unleveraged index fund?

Perhaps the buyer is looking for a little bit of the same kind of exciting financial returns you used to be able to get buying real estate for investment with zero down payment.
posted by sfenders at 4:13 AM on November 15, 2008

So there is actually some advantage for the ETF company to using the 3x leverage

Small time traders just buy and sell small lots of existing shares of the fund on the open market through brokers. However, if you read their prospectus, you'll notice that large investors buy and sell "creation units" of 100,000 shares directly from the fund, and incur fees when doing so. These fees are part of the fund's income. The other part comes from the fact that they are running both bull and bear funds, and can therefore take advantage of arbitrage opportunities, the profits from which don't always have to be dispersed to the funds to make their +/-300% tracking goals.
posted by fatllama at 4:50 AM on November 15, 2008

what's the incentive to the purchaser of the ETF, what does it get them over buying 3x an unleveraged index fund?

Is it possible to get a 3x fund without leverage? I thought that was the entire point of leverage. Also, how do these funds compare to the Proshares "Ultra" (2x) funds?
posted by knave at 5:13 AM on November 15, 2008

"if you like to go skydiving, keep a pet alligator in the bathtub, and dream of a winter king crab fishing in the Bering Strait, then you will be right at home with the Direxion ETFs."

ARE YOU A BAD ENOUGH DUDE to give us all your money and leave us rich and you poor?
posted by TheOnlyCoolTim at 5:18 AM on November 15, 2008

It's possible to do more or less the same thing yourself. Let's say you have $1000 to invest.

1. You borrow $2000 and add this to your $1000. You now have $3000.

2. You invest the $3000 in the index ETF of your choice. You now have 3x leverage. Obviously you need your investment to be returning more than the 3x the risk-free rate to make money.

In fact this is a much better deal long-term than a 3x ETF, because they rebalance at the end of each trading day, which will eat away your capital long term.

Here's how the 3xETF really works (sort of):

They start out with $1000 in the 3x long and $1000 in the 3x short. They short $2000 worth of the underlying index and go long $2000 worth of the underlying index.

So at the beginning of day zero they have an absolutely neutral position.

At the end of day zero, whatever the underlying index has done, they've done 3x that. So if it's up 5%, they're up 15%.

However, their position is now unbalanced. So they now rebalance the long/short positions to bring it back to neutral. So if the index has gone up, their long positions are worth more than their short. So they short more and reduce their long holdings.

The problem is, this is a well known way of losing all your money.

Therefore some people think a valid long-term investing strategy is to short the 3x long ETFs and long the 3x short ETFs.

All that said, the leveraged ETFs are a fantastic trading vehicle in volatile markets. Using simple moving average crossover strategies and closing positions at the end of the day could have netted you 100% or 200% or even higher returns since the beginning of the year on funds like SSO and URE.

It remains to be seen how tradeable the 3x ETFs are, since the spreads were pretty high to start out. But potentially they are an ATM for nimble traders.

They can also be used as a cheap way of hedging a portfolio. Let's say you have a bunch of long positions worth $30000 which you think will out perform their peers. But you are worried about an overall downturn. You could hedge with $30000 in an unleveraged bear ETF, or $10000 in a 3x bear ETF. The tradeoff is that long term the $10000 in the 3x fund will underperform the $30000 in the unleveraged fund.
posted by unSane at 6:25 AM on November 15, 2008 [1 favorite]

300% LEVERAGED THIRSTPOCALYPSE
posted by East Manitoba Regional Junior Kabaddi Champion '94 at 7:11 AM on November 15, 2008

I love to places all my armies in Kamchatka and invade Alaska, much to the chagrin of Sarah Palin.

/ Not that Risk? But that's the only Risk I love!
posted by educatedslacker at 9:31 AM on November 15, 2008 [1 favorite]

So I was listening to a segment on the radio, about "investing" in poker players in the World Series of Poker. Pay their entry fee ($10K), get a cut of what they win.

The segment was utterly unaware of its own irony.
posted by effugas at 11:45 AM on November 15, 2008

HAHA OK, NO. These are leveraged IWM. No freaking deal, IWM has lower volatility compared to other ETFs on the market. FXI has a significantly higher volatility without leverage, and the net risk of a 2x inverse FXI ETF, FXP, is guaranteed to be a lot crazier than a scary sounding 3x inverse IWM ETF.

It's not the leverage that makes these ETFs a bad idea, it's using these ETFs for anything more than a day-trade, because they're designed to go to zero. A guaranteed way to make free money is to pair-trade short 2x (or 3x) ETFs. Eg, short 1sh QID and short 1sh QLD, because both have fees and are designed to go to zero and are pretty well hedged (because they're the same share underlying, QQQQ). The difficulty is every friggin hedge fund knows about this and you can't get short one side or the other because the moment a share comes available to short, it's snatched up by those funds.
posted by amuseDetachment at 11:50 AM on November 15, 2008 [1 favorite]

A guaranteed way to make free money is to pair-trade short 2x (or 3x) ETFs. Eg, short 1sh QID and short 1sh QLD, because both have fees and are designed to go to zero and are pretty well hedged (because they're the same share underlying, QQQQ).

Exactly right. I tried to short BGZ and BGU on Thursday but couldn't borrow any shares.

In a "regular" market (not now) you can even enhance the return. Short QLD on a nice up day and Short QID on a nice down day, both trades proximal to each other and in no particular sequence. Now you have a spread plus the decay of both. But this is not normal times or markets. Personally, I've been building a long QID position for 15 months and now I'm adding to it by buying ITM QLD puts all the way out to April. Also building positions in foreign currency ETFs, I just don't see the dollar staying strong forever. Starting to build a small position long on Crude, but this is more of a hedge than anything else.

Fact is, we're in a deflationary period right now. Jobs are lost, prices go down. Jobs are lost, prices go down. Rinse. Repeat. OTOH, all the liquidity that's being thrown at the markets right now could do a semi-quick reversal into inflation. Unfortunately, there is not enough people(demand) or money in the world to rescue the real estate market quickly so RE equities can do nothing but dwindle which amplifies consumer frugality trends which continues the deflation. Short of sending US taxpayers charged up debit cards that themselves decay if not used, there is no short term way to drive consumers back to the stores. In Japan the government sent out purchasing coupons to the masses. They took the coupons and purchased something small, resulting in a relatively large amount of "change" returned as currency. They took the change and saved it. When the consumer wants to spend, it's easy to accelerate their spending with credit. When the consumer wants to save and you'd like them to spend instead, you're SOL.
posted by Rafaelloello at 1:29 PM on November 15, 2008