Tuesday, April 14, 2009

When Leverage and Volatility Collide in ETFs (FAS, FAZ)

David Gaffen gets the understatement of the day award. I called them "beasties" back in November.
From MarketBeat:

When compounding interest meets leverage, the results can be pretty insane.

Investors have been delighted at the performance of the financial stocks since the market bottomed out on March 9, but the performance of leveraged exchange-traded funds is even more dramatic.

Since March 9, the Russell 1000 Financial Services Index has gained more than 62% as banks surged on the back of positive commentary from executives and improved economic data. The Direxion Financial Bull 3X exchange-traded fund, which seeks to provide three times the return of that index for one day, is up 260% in that time, while Direxion’s Financial Bear 3X fund, which seeks to provide three times the inverse of the index’s performance, is down 90%.

In that five-week period, financials have been fairly predictable, rising on most days. But a look back at longer performance periods – and these ETFs in particular were only introduced in November – shows how additional leverage can crash into volatility to produce truly ugly results...MUCH MORE

Even though he uses forceful language (albeit with a 'pretty' modifier), that first sentence is still an understatement!

One quibble, there is no mention of time premium decay which was the whole point of our one line comment on last weeks post, "Direxion 3x Financial ETFs Go Certifiably Crazy (FAS; FAZ etc.)":

One approach is to short both of them, in effect writing an option. Ooops, have I said too much?

So I'm economical with words.


Nov. 4: Action Baby, Action: "Leveraged ETFs With 300% Exposures Set To Launch"

Nov. 26: 3X ETF's On Fire

...Today Bespoke looks at their first three weeks of trading. Our Nov. 4 headline was too subdued....