Leveraged ETFs: Friend or Foe?
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Exchange-traded funds. or ETFs, were the darling of the investing community when they were first introduced some years ago. A basket of securities in one easy-to-buy security. Access to unaccessible markets. The diversification of a mutual fund without all the fees. Where do I sign up?
Morningstar believes that ETFs now account for 35 to 40 percent of trading volume on any given day.
However, the evolution of the ETF has led to offerings that are highly levered against such things as the overall market, currencies, and metals, just to name a few. And now these leveraged-beasts have grabbed the attention of regulators.
According to the WSJ, the SEC is including the ETFs, as well as leveraged mutual funds, in its inquiry into exotic trading vehicles and high-frequency trading (HFT).
When markets were experiencing increased volatility following the downgrade of U.S. debt by S&P, causing markets like the Dow Jones Industrial Average to swing over 400 points into positive and negative territory over a four day period for the first time in its history, many HFT firms were posting high profits.
But with leveraged ETFs aimed at more of a short-term holding position, many individual investors, those not involved in HFT schemes, find that losses can be as large as profits.
Recently, the SEC spoke with Interactive Brokers (Nasdaq: IBKR) CEO Tom Peterffy. He was asked whether leveraged ETFs add to market volatility at the beginning or end of the trading session, to which Peterffy replied that market makers buy and sell underlying assets in ETFs at the beginning and end of the trading session to rebalance their portfolios. Should the market make a big overnight move, or during trading hours, market makers must buy larger chunks of stocks over a short period of time.
Peterffy also told the SEC that ETF trading can make big market swings anytime during the trading day.
Another analyst said that half of the trading done on exchanges are from HFT outfits, and the new vehicle of choice is leveraged ETFs.
Conversely, a researcher from Morningstar said that although leveraged ETF trading picked up during the first few weeks of August, they likely had a minimal impact due to not enough cash being invested in the funds. He contends that big market swings are more likely done by mutual funds looking to ease nerves of jittery investors in times of turmoil, like in early August.
Even so, the SEC commented that the "flash crash" of May 6, 2010, was primarily due to HFT funds aiming to exit positions, as well as a combination of heavy futures and ETF selling.
Some long index leveraged ETFs include ProShares Ultra S&P500 (NYSE: SSO) and ProShares Ultra QQQ (NYSE: QLD). Short index ETFs include ProShares UltraShort S&P500 (NYSE: SDS) and ProShares UltraShort QQQ (NYSE: QID).
Morningstar believes that ETFs now account for 35 to 40 percent of trading volume on any given day.
However, the evolution of the ETF has led to offerings that are highly levered against such things as the overall market, currencies, and metals, just to name a few. And now these leveraged-beasts have grabbed the attention of regulators.
According to the WSJ, the SEC is including the ETFs, as well as leveraged mutual funds, in its inquiry into exotic trading vehicles and high-frequency trading (HFT).
When markets were experiencing increased volatility following the downgrade of U.S. debt by S&P, causing markets like the Dow Jones Industrial Average to swing over 400 points into positive and negative territory over a four day period for the first time in its history, many HFT firms were posting high profits.
But with leveraged ETFs aimed at more of a short-term holding position, many individual investors, those not involved in HFT schemes, find that losses can be as large as profits.
Recently, the SEC spoke with Interactive Brokers (Nasdaq: IBKR) CEO Tom Peterffy. He was asked whether leveraged ETFs add to market volatility at the beginning or end of the trading session, to which Peterffy replied that market makers buy and sell underlying assets in ETFs at the beginning and end of the trading session to rebalance their portfolios. Should the market make a big overnight move, or during trading hours, market makers must buy larger chunks of stocks over a short period of time.
Peterffy also told the SEC that ETF trading can make big market swings anytime during the trading day.
Another analyst said that half of the trading done on exchanges are from HFT outfits, and the new vehicle of choice is leveraged ETFs.
Conversely, a researcher from Morningstar said that although leveraged ETF trading picked up during the first few weeks of August, they likely had a minimal impact due to not enough cash being invested in the funds. He contends that big market swings are more likely done by mutual funds looking to ease nerves of jittery investors in times of turmoil, like in early August.
Even so, the SEC commented that the "flash crash" of May 6, 2010, was primarily due to HFT funds aiming to exit positions, as well as a combination of heavy futures and ETF selling.
Some long index leveraged ETFs include ProShares Ultra S&P500 (NYSE: SSO) and ProShares Ultra QQQ (NYSE: QLD). Short index ETFs include ProShares UltraShort S&P500 (NYSE: SDS) and ProShares UltraShort QQQ (NYSE: QID).
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