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?
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.)
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.
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.
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
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.
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!!!!