| More Opportunities with Leveraged ETFs |
Volume in leveraged ETFs has continued to grow as more traders turn to these instruments for efficient strategy execution. For example, average weekly volume on SDS (the Ultrashort ETF of the S&P 500) has increased from nearly 1,000,000 shares a week in 2006 to 347,000,000 shares a week in 2009. Despite the advantages and growth in leveraged ETFs, there are some mild disadvantages that traders should be aware of as they make strategic choices.  
Learn more about leveraged ETFs with the first article in this series 1. Leveraged ETFs have higher costs Leveraged and/or short ETFs represent positions in the market that would normally require margin. Leveraged and/or short positions generate costs. While the costs the ETF incurs (and passes on to its shareholders) are small relative to the expenses generated by using margin in a retail brokerage account they are still an additional cost. For example, SDS has an expense ratio of .91%, which is much higher than SPY (the unleveraged long ETF version of the S&P 500) which has an expense ratio of .10% 2. Leveraged and/or Short ETFs under-perform in the long term On a daily basis if SPY were to lose 3% SDS would be expected to gain 6%. This is generally true and a good example of the value offered by a leveraged short ETF. However, because the ETF is rebalanced on a daily basis it does not enjoy the same benefits of compounding that an outright long position on the SPY does over the long term. For example, since the market top in late 2007 the SPY is down approximately -50%. Without digging into the numbers, you might expect SDS to be up 100% (twice the inverse of the index) however, that is not the case. SDS is up only 73% since the 2007 market top. This difference is created by the need for daily rebalancing, which negates some of the benefits of compounding. You can show why this is the case through a complicated mathematical calculation but the bottom line is that over the long term, you should expect a leveraged or short ETF to under-perform what you may have expected with compounding. This problem is more pronounced during periods of high volatility and is less of an issue when market volatility is lower. The question that investors should be asking is whether these disadvantages are a reason to exclude these instruments as a strategic tool. All investments have downsides and disadvantages that should be considered and balanced. For short term exposure to the bearish side of the market, leveraged and/or short ETFs can be an efficient strategy while longer term exposure to the downside of the market during periods of high market volatility may be better accomplished with long term puts or put LEAPs. There are no "magic bullets" for making money in the market. It is usually a matter of finding the right tool for the right opportunity. Knowing what alternatives are available will help you make the right choice for your portfolio and strategic objectives.
Comments deemed inappropriate will be removed
3.25 Copyright (C) 2007 Alain Georgette / Copyright (C) 2006 Frantisek Hliva. All rights reserved." |
| Learning Markets Partners More Partners | Become a Partner |
 |  |  |  |  |
 |
| Learn to Invest | Reviews of Stock Brokers | Stock Picks | Technical Analysis | Broker News | Investor Education | What to Invest In | Live Market Analysis | Should I Invest? |
