Taipan Daily
Leveraged ETF Guide Print E-mail

Leveraged ETF Guide

Do Not Use a Leveraged ETF for Hedging

A Taipan Publishing Group Strategy Report
By Manshu Verma, Guest Contributor, OneMint.com

When I read about a Leveraged ETF for the first time, I wondered, who will be interested in such a product?

A leveraged ETF is too fancy a product for long-term investors, or even other ordinary investors. I think a person who can be interested in an ETF – that is good, only, for a day (and understand that fact) – should be sophisticated enough to buy derivative options himself, and create a similar product. This will save a lot of costs, and will certainly be a lot more exciting than simply buying an ETF.

Hedging With a Leveraged ETF

Then I came across this interesting question in The Dividend Guy’s Web site – Could you hold 75% of your portfolio in stocks, and buy 3X Leverage Funds that short the market?

So, theoretically, you have 3/4th of your portfolio in common stocks, and 1/4th of your portfolio is invested in a product that shorts the market 3 times.

Taipan Daily

Just the Right Balance of Safety and Adventure for Your Investment Profits

"For more than a year I've followed your results and comments... the only word I can use to describe my experience is 'fantastic'." -- John, member

Taipan Daily is your FREE resource for late-breaking investment opportunities to help you beat Wall Street to the profits. Filled with investment analysis and insight from every sector (from blue chips to small caps... options to ETFs... emerging markets to the tech sector), Taipan Daily delivers just the right mix of safe opportunities with the fast-moving plays, so you have an insider's edge over the Street... and other investors.

Enter your e-mail address below and click the Join Us button to begin receiving your e-alerts.


We value your privacy! We will never rent or sell your e-mail address to another company.
Jeanne M. Smith, E-Commerce & Customer Satisfaction Director

While, the idea itself is good, the daily nature of Leveraged ETFs do not allow them to be the right tool to execute this strategy.

A Leveraged ETF uses daily leverage and that is what makes all the difference – Daily Leverage. Let me take an example of how this would work:

Suppose, we have an Index and it moves in the following manner:

Day 1, Index Value - 1000

Day 2, Index Value - 1050 (Gain of 5%)

Day 3, Index Value - 1000 (Loss of 4.76%)

An ordinary ETF will give you no profit, no loss – in such a situation.

However a Leveraged ETF, that needs to lever itself every day will move in a different manner. A 3X fund will gain 15% on the first day, and then lose 14.28% (4.76 x 3) in the second day.

Here is how it will look:

Day 1, Index Fund - 1000

Day 2, Gain of 15% on 1000: 1150

Day 3, Loss of 14.28% of 1150: 985.78

So, even though the market didn’t move at all – you stand to lose money on your investment.

When looked at from a Hedging perspective – your portfolio of stocks has netted you no gain, but your Leveraged ETF has caused you a loss.

That makes this product really bad for hedging. Unless, of course – you have the time and ability to counter the daily leverage, and balance your ETF investment daily.

What Else Can You Do With a Leveraged ETF?

You can lose a lot of money.

This product is not for any investor who wants to hold their money in a derivative instrument for more than a week.

I share the same skepticism as Invest Skeptically, when it comes to this new product. The fee is high, tracking error should be high (although I don’t have data on this), it is a leveraged product, so there is a risk that the counterparty will default, and it is too complicated a financial product to execute it successfully, and without losing a lot of money.

The Rich Get Richer

If you had Wall Street’s resources... their inside information... their media connections... and their financial muscle, you could make a killing, too.

This brings me to the incredible opportunity the U.S. Government has presented us. Let me tell you about it...

Originally published: January 15, 2009

Other Related Topics: Exchange-Traded Fund , Manshu Verma , OneMint.com

Also By This Author

Article site: http://www.onemint.com/2009/01/15/do-not-use-a-leveraged-etf-for-hedging/

About the Author

Manshu Verma is the founder of OneMint.com, whose vision is to “Create Wealth for Everyone.” OneMint.com disseminates knowledge about subjects related to money to help investors grasp the world of finance and global financial markets.

Visit http://www.onemint.com/

Comments (0)Add Comment

Write comment
smaller | bigger

busy
 
Copyright 2009 Taipan Publishing Group LLC and Taipan Daily, 16 W. Madison St., Baltimore, MD 21201. All rights reserved. No part of this report may be reproduced or placed on any electronic medium without written permission from the publisher. Information contained herein is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. Taipan Publishing Group or its editors and publications do not advocate the purchase or sale of any security or investment. Investments recommended in this publication should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company in question. Taipan Publishing Group expressly forbids its writers from having a financial interest in any security that they recommend to their readers. Furthermore, all other employees and agents of Taipan Publishing Group and its affiliate companies must wait 24 hours before following an initial recommendation published on the Internet, or 72 hours after a printed publication is mailed.

More FREE Investment Research Reports