The position has to be rebalanced during periods of low volatility monotonic (same direction) moves so that one side or the other doesn't balloon in size to the point that, although the percentage moves are equal and opposite, the resulting dollar amounts are completely out of whack.
Watch your gamma, gramma.
From Bloomberg via the Houston Chronicle's FuelFix blog:
Chris Santos likes a little spice in his investing life.
That’s why the 26-year-old Toronto man trades Credit Suisse Group AG’s VelocityShares 3x Long Crude ETN, which offers returns equal to three times the move of the S&P GSCI Crude Oil Index for each day. It’s allowed him to leverage the volatility of the fast-moving oil market in a year in which prices have flipped five times between bear and bull markets as investors weighed how quickly a global supply glut might ease.
“There’s a theme among the younger generation to try to get rich quick,” Santos said. The oil market’s been “like a roller coaster. … Ultimately, that’s why I’m trading this position. It’s been pretty volatile lately, with these huge swings. It’s kind of fun.”
ETNs, or exchange-traded notes, are similar to exchange traded funds, or ETFs, in that they both trade on exchanges and track an underlying asset. However, while an ETF will usually hold the assets it tracks, an ETN is an unsecured debt note issued by a bank. It allows leveraged exposure and no tracking errors, but also increases risk since it’s linked to the issuing institution’s credit.
Santos isn’t alone in his investment choice. TD Ameritrade lists the Credit Suisse ETN, known by its UWTI ticker, fifth among the top securities traded by those aged 18 to 34, after Apple, Netflix, Facebook and Walt Disney Co. While the risks with ETNs may be as significant as the gains, Santos, for one, said he is OK with that.
‘I can afford to lose money’
“I’m young,” said Santos, who noted that most of his personal portfolio is in more diversified traditional funds. “I can afford to lose the money.”
More cautious investors, however, probably want to stay better grounded, said David Fabian, managing partner at FMD Capital Management in Irvine, California. These ETNs magnify both gains and losses, and the fact that UWTI resets at the end of the day hinders long-term performance, he said.
Fabian said he advises people not to trade the note and its short counterpart, the VelocityShares Daily 3x Inverse Crude ETN, and doesn’t do so himself.
“It’s almost like going to the craps table and saying, ‘I’m going to put it on the black or I’m going to put it on the red,”’ said Fabian, who manages $13 million in discretionary assets. “It has more to do with a gambling and trading mentality than a true investing mentality.”
“There’s a lot of juice if you have a short-term tactical outlook and you want to take a risk with some big reward,” said Jason Bloom, director of commodities and alternatives research and strategy at Invesco Advisers Inc., who emphasized that leveraged ETNs are appropriate only for short-term bets and those with a higher risk tolerance. “It certainly provides entertainment.”
Credit Suisse writes in its prospectus that the ETNs “may not be suitable for investors who plan to hold them for a period other than one day. They are designed to achieve their stated investment objectives on a daily basis, but their performance over different periods of time can differ significantly from their stated daily objectives.” The company declined to comment further.
Still, ETNs are drawing converts. This year, UWTI attracted an average of $400 million a day in trades. Its turnover rate, the percentage of its $1.2 billion in assets traded each day, is about 40 percent, according to data compiled by Eric Balchunas, a Bloomberg Intelligence analyst. That’s more than four times the rate of State Street Corp.’s broad-based Energy Select Sector SPDR exchange-traded fund and almost 40 times the popular Vanguard S&P 500 ETF....MORE
