On Monday, we had this thread about how ETFs are potentially dangerous in the sense that investors wouldn't evaluate the underlying assets before buying them. Just yesterday, the SEC approved a request to list and trade 4x levered ETFs. For right now, it looks the the only funds in the works are for the S&P 500 and an inverse S&P. I would imagine that in the near future, they would start listing 4x levered ETFs for commodities, emerging markets, and volatile sectors.
I just get the feeling that this could get out of hand really quick. What do you guys think?
JTH I'm not familiar with the particulars but I wonder if this is any different than the MBS products being sold by investment banks pre-2008 financial crisis?
The SEC is the one approving these ETFs so I'm assuming they're scrutinizing the products far more than rating agencies did with what I've discussed above.
As to your point I can see it getting out of hand but who would actually invest in these and why? Unless its cheap for average Joe the risk/reward doesn't seem to be worth it IMO.
Also why stop at 4x? Why not try for a 5x, 10x, etc and race to make and gain approval for the most outlandish ETFs? /s
I think that's kind of what I was trying to get at. My thought was that average investors would buy these only considering the possibility of getting 400% returns on the index without considering the equally enormous downside potential. I don't think any sort of institutional investor, RIA, CFA, CFP type would buy this, but I think that someone relatively uninformed about markets would end up buying this on their own. If someone has a personal account that they're using to try to get rich quick, a 5x, 10x, etc leveraged ETF would serve the same purpose that going 50% long Amazon, 50% long Tesla would.
I trade ETFs (both linear and leveraged) on a daily basis. From experience, this is nothing to be worried about. Just that one's gains will be amplified, as well as losses. It also frees up additional capital in your trading account. So say you want to have $280k of exposure to the SPY. Well, now you only need to tie up $70k, allowing you the remaining to hedge/take new positions.
Except $70k in a leveraged ETF does not give you the same returns as $280k in the underlying.
Wait, can you break down the math. My initial thought process is that 70k with a 40% (10% x4) return results in 28k. 280k at a 10% return is 28k. How is the return not the same?
Last spring, there was some serious money to be made on UWTI and DWTI.
Oh yes. Thank god I had little to do at school at that time.
Leveraged ETFs give you leverage for one day....most retail investors don't understand that.
Short it for decay.
Can you elaborate on this?
1. ETFs must pay for operation, therefore they have a Beta of 0.999––not 1, assuming that no leverage is involved.
2. ETFs that are leveraged make adjusts on the day to carry out their promised rate. If it is a 3x and somehow they don't meet it, they will make active adjustments to meet their target, often slightly falling short because of the fees incurred with operation as mentioned above.
3. It is possible that the underlying and a 3x ETF become wildly disconnected from each other's prices over time. For example, say the underlying moves: +10%, -5%, +12%, +8%=25% returns. The 3x ETF will have moved 79.98%, after fees are paid. Therefore the expected price move of 75% actually overshot expectations on the count of its obscene leverage.
EDIT: #3 is partially incorrect. I forgot to account for the principle's changes in price when adjusting for percentage changes. It would actually become more exaggerated because each day would yield a different amount depending on how much it has changed in previous days.
Two words: leverage decay.
Not an issue.
if they hold it long term, don't see many issues. It only goes up. If it stays down, you probably have bigger issues to worry about.
Buy and hold is not wise, it will lose value overtime as the fund is trading index futures. For shorter term trade I may not be a bad idea, but going out past a few days could have issues.
Could you explain why it will lose value over time?
X, you are either very stupid, or very sarcastic.
The problem here is with how these products work. Leveraged ETFs are only tied to the underlying index on day 1 of trading (not really, but the "starting point" is the same). Afterwards the ETF replicates the relative change in price, not the absolute change. The implication from that is that losses are more severe and take longer periods of gains or greater gains to recover because of the proportionally smaller asset base in the leveraged fund. Similarly after a period of gains, losses will weigh much heavier because of the greater asset based of the ETF. As leverage increases, ETFs become exponentially more risky. Take the following example of a 4x levered ETF:
Index is at 100, ETF is at 100 on opening of day 1 trading.
T1: Index is **down **1%. ETF is **down **4%
Index: 99.0; ETF: 96.0
T2: Index is **down **1%. ETF is **down **4%
Index: 98.0; ETF: 92.2
T3: Indexis **down **1%. ETF is **down **4%
Index: 97.0; ETF: 88.5
T4: Index is **down **1%. ETF is **down **4%
Index: 96.1; ETF: 84.9
T5: Index is **up **4%. ETF is **up **16%
Index: 99.9; ETF: 98.5
Bear in mind, the ETF has to be rebalanced every day. This allows it to track the performance of the underlying index accurately, but also locks in every single day of trading losses - and in this case quadruple the losses. At best this is a speculative investment to be held for a really short period of time. Even more leverage would be pointless as the fund could be wiped out within a day or two if an unforeseen/ unlikely event occurs (Brexit, LePen wins, Sanders wins, major corporation goes down, etc.)
Great post !
The smart guys on Wall Street wouldn't do anything to enrich themselves that could potentially have extremely negative consequences. I wouldn't worry about it.
I dont think there's much to worry about - just because an instrument is leveraged and synthetic doesn't really mean much in and of itself.
'08 was only possible because of the magnitude of the market for those synthetics, and a combination of perverse incentives which basically warehoused tremendous amounts of hot potatoes on the balance sheets of major institutions. The economic contagion witnessed in '08 was the cascading effect of a very intricately laid and precariously balanced set of circumstances.
For now, I don't see anything super remarkable about 4x levered ETFs, they're just another high beta instrument that traders will try to exploit for a profit. And when and if those traders fail to obtain a profit, the financial consequences will be confined to their bank accounts.
Currently in the process of liquidating my entire book and buying this with as much additional leverage as my primes will give me. Will update soon.
This is WSO not WSB
I have no idea what wsb is
My friend, I have an investment opportunity for you. It's a highly leveraged ETF that tracks a basket of highly leveraged ETFs - but get this - the underlying basket is itself comprised of baskets of highly leveraged ETFs.
It's all on the up and up, and very financially savvy.
Wow. Revolutionary. My people will be in touch.
(In all seriousness, I wonder if Nigerian "princes" will start pulling this kind of shit)
This doesn't quite cut it TBH. I was looking for a 70,000x levered ETF. That's what I need for my risk/return profile
Sign me up today.
The sharpe ratio is spectacular!
You guy's are the typical "retail", non sophisticated traders-- the very ones targeted by ETF issuers.
Just because there's more leverage should NOT be an invitation to take more risk than he/she can handle.
For example, a new trader starting out with a $50k account should NOT suddenly think "wow this 4x ETF... now I can have $200k of buying power, let's go all in long/short the index!". No, no no.
What you SHOULD be thinking is "so I originally planned to put $50k towards the index using a non-levered instrument. But look what I found, a new 4x ETF, now I use $12,500 towards this trade and have the rest put away in cash / hedging trades. Awesome!"
Risk management is key.
Someone hire this guy NOW! I've never thought of it this way. Who knew that I shouldn't be taking more risk than I can handle?
Thank you for enlightening us.
If ANYONE EVER accuses you of not having a basic familiarity with the extraordinarily obvious, you can point them to this thread. Yes, yes, yes. You can.
If anyone ever asks you to divide something by 4, feel confident that you can do so. As long as it is a whole number and divisible by 4. GOOD LUCK!!!!
LOL very sophisticated indeed
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