http://www.canadianbusiness.com/markets/stocks/article.jsp?content=20091022_160526_756&utm_source=_BK4MzRB7wGPl5n&utm_content=mwnl15&utm_medium=email

The ignorant – and that’s not meant to be disrespectful – the truth is that most individual investors are ignorant – simply don’t know that these instruments are for day traders only.

But Direxion and others of their ilk know it. And they choose to profit from them. Despicable.

FAS and FAZ both did reverse splits as the were both down 80% in June. Look it up. The real facts. Not this article of nonsense.

I certainly wouldn’t advocate putting an inordinate amount of money in any leveraged ETF.

From what I’ve seen, the extreme scenarios which are often touted don’t match the theory.

One example I could come up with (since they are relatively new) is comparing XIU to HXU. Adjusting for splits and dividends, from May 08, 2008 to March 2, 2009 the XIU was down about 48%. HXU was only down about 78%, not 96%. HXD, the inverse of HXU, was up 121%.

If you had bought 900 shares of HXD and bought 400 shares of HXU in May 2008 your outlay would be about the same $14,400 in each case. In March 2009 you could have closed out your positions and been up about $17k on your HXD and down about $11,200 on your HXU.

SSO and SDS are 2x leverages on the S&P500. Same timeframe: buy 300 of the SSO (Bull) and 500 of SDS (Bear) for an investment of about $22,500 in each. You would be down about $18k and up about $33k on the SDS.

On the other hand, if you bought 200 SDS and 900 SSO at March 2 2009 (investing about $22.5k in each) you would be down about $14k on SDS but up about $16k on SSO.

It wouldn’t surprise me that if you invested in equal amounts in leveraged ETFs both Bear and Bull components you will eventually come out ahead due to the drag. And, if you have a long term view, it would be better to short the Bear rather than buy the long.

Do you not think that shorting a triple ETF is way to risky?

The worst case scenario with buying them is that if the index moves against you by 33%, then you lose 100% and are wiped out.

However, if you short them, then the risk is unlimited x 3. If the market moves 100% against you, then you are out 300%. This means that if you sell short for $10,000, you would need $30,000 to get out of it.

Especially shorting the 3 times bull would be scary, since the market is does rise in the long run. Shorting it for any length of time means losing 100% is not merely possible – but probable.

Do you have a way to protect against this extreme risk, Cannon?

Ed

The second is that the ETF has a drag on its tracking the underlying index. This is why I believe there is a potential long term strategy for these ETFs. It is based on empirical evidence that these 2x or 3x ETFs have a tracking error such that moves up are always a little less and moves down are always a little more than intended. Pick a direction that you think the underlying index will move and sell short the opposite ETF.

For example, a year ago you thought that the S&P 500 was overpriced and should move lower. Instead of buying a 2x or 3x Bear on the S&P, you short the 2x or 3x Bull. Over the next year, the S&P index was down about 20%. If you had purchased Proshares 2x Bear you would be DOWN about 30% (huh?!). On the other hand, if you had shorted the 2x Bull you would be UP about 50%.

Thus, even if you had guessed horribly, terribly wrong and though the S&P was going to move higher, and thus shorted the S&P Bear, you would be up 30%.

I’ve not done extensive analysis, but it is a strategy I’ve recently adopted for small positions to see if theory put into practice yields expected results.

I agree. This type of investment is not suitable for a long term hold. It will likely go down, even if the underlying index is rising.

To show the correct math on your example, if the index rises 25% and then falls back to 100 (a 20% decline), then this ETF would rise to 175 (25% x 3) and then fall 60% (3 x 20%) from 175 to 70.

In short, the index goes from 100 to 125 to 100, but this ETF will go from 100 to 175 to 70. Your return is a 30% loss while the index was flat. Note this is before fees.

A more extreme example is if the index goes from 100 to 67 and then back up to 100. This ETF will fall from 100 to 0 and then stay there. This is a 100% loss while the index was flat.

The same effect happens with the 2x ETFs.

Ed

I think you’re misunderstanding the math. These products don’t “reset” each day. You’re just looking at day-over-day +/- %’s. Rising 25% one day, and falling 25% the next does ~not~ mean the index was “even” over those two days. Each day builds on the next. You can’t just add the numbers up.