Clicky

Archives

March 2017
MTWTFSS
« Feb  
 12345
6789101112
13141516171819
20212223242526
2728293031 

The Pros & Cons Of Trading Leveraged ETFs vs. Non-Leveraged ETFs

I've clearly stated my expectation for a correction in the semis recently & just wanted to share some thoughts on how to position for a correction in the semis, for those that share my outlook for the sector. In doing so, I also wanted to address the advantages & disadvantages of trading leverage ETFs in lieu of non-leveraged ETFs.

As per yesterday's video on the semiconductor stocks, for those comfortable with shorting individual stocks & have enough capital to properly diversify among various semi stocks, in order to mitigate the risk of any one stock moving sharply against your position, shorting at least 4-6 individual semiconductor stocks with the most promising (bearish) charts is an option.
For those that prefer trading ETFs, either due to the fact that they provide both diversification by holding many different semiconductor related stocks, as well as the fact that the risk of an unusually large gap against your position due to an earnings report or some news related to that specific company, here is a list of various ETFs to trade the semiconductors:

  • 1x bullish (long): SMH, XSD, SOXX
  • 2x bullish: USD
  • 2x bearish: SSG
  • 3x bullish: SOXL
  • 3x bearish: SOXS

For some reason, most likely the leverage they provide, many retail traders seem to prefer to buy (go long) the 3x leveraged ETFs despite numerous warnings from most brokers as well as the leveraged ETF providers themselves that these instruments are not suitable for much more than just quick in & out trades (typically day trades). This applies to both bullish (i.e. buying or going long) & bearish (buying an inverse/short leveraged ETF to gain short exposure to an index, sector or commodity) positioning.

Other than using put options, buying an inverse (short/bearish) ETF is pretty much the only way to gain short exposure within a non-margin (cash) trading account or an IRA (as shorting is prohibited in IRAs), it often isn't the best choice within a typical trading (margin) account. In the case where one wants to short within an IRA or cash account, either as a pure-play short or as a hedge to existing long positions, I would suggest reading this post from January 2015 titled Leveraged ETF Price Decay Explained.

First & foremost, there is the decay suffered by the leveraged ETFs ,whether bullish or bearish, when held for an extended period of time. Another factor to consider, again when trading these in a margin account, is that all other things being equal, you don't gain anything by going long or short a leveraged ETF other that the potential to profit from the decay if shorting a leveraged ETF during a choppy market (and assuming that the overall trend is moving in the direction that you have positioned for).

What one must realize is that most, if not all, brokers account for the amount of leverage an ETF employs when you short it or go long for that matter. For example, if you short $10k of SOXL (3x bullish/long semiconductor ETF) to gain short exposure on the semiconductor stocks, you are burning up the same amount of buying power (margin) in your account as you would if you had shorted $30k of SMH (again, all other things being equal as some brokers might slap on different margin requirements to certain ETFs and other securities).

The following is an excerpt from Interactive Brokers Margin Requirement on Leveraged ETF Products:

Leveraged Exchange Traded Funds (ETFs) are a subset of general ETFs and are intended to generate performance in multiples of that of the underlying index or benchmark (e.g. 200%, 300% or greater). In addition certain of these ETFs seek to a generate performance which is not only a multiple of but also the inverse of the underlying index or benchmark (e.g., a short ETF). To accomplish this, these leveraged funds typically include among their holdings derivative instruments such as options, futures or swaps which are intended to provide the desired leverage and/or inverse performance.
Exchange margin rules seek to recognize the additional leverage and risk associated with these instruments by establishing a margin rate which is commensurate with that level of leverage (but not to exceed 100% of the ETF value). Thus, for example, whereas the base strategy-based maintenance margin requirement for a non-leveraged long ETF is set at 25% and a short non-leveraged ETF at 30%, examples of the maintenance margin change for leveraged ETFs are as follows:
1. Long an ETF having a 200% leverage factor: 50% (= 2 x 25%)
2. Short an ETF having a 300% leverage factor: 90% (= 3 x 30%)

Bottom line: Unless you are shorting a 3x long ETF to gain short exposure plus the possibility of additional gains from any decay, assuming that you plan to hold the position for an extended period of time (or shorting a 3x short ETF to gain long expsosure), then there really isn't much of a benefit to either going long or short a leveraged ETF within a margin account, especially considering that the non-leveraged (1x) ETFs, such as SPY, QQQ, SMH, XSD, etc... often have better liquidity and therefore less slippage.

Mar 3, 2017 11:07am|Categories: Trading Tips|Tags: , , , , , , |1 Comment

One Comment

  1. Profile gravatar of GetItRiight
    GetItRiight March 3, 2017 4:52 pm at 4:52 pm

    While there is no doubt in my mind about the dangers of holding leveraged ETFs for a longer time frame than 1 week or 2, I managed to pull off multi week swing trades using leveraged ETFs, even when they went against my entry position. The key is to manage that position by averaging down at support levels and take emotion out of that trade.
    First of these trades started in mid November last year during the initial miner selloff, when a bounce was looking likely. I started layering in JNUG at key points. If it went lower and my loss went beyond 10%, I added another tranche. I kept doing that until I got to the maximum amount I had allocated to that trade. My average for JNUG was around 6. The low point was 3.77 on Dec 20. I held the position until Jan 4 when I sold at 6.8. Had I held longer, I could have gotten to around 12 on JNUG, but was happy with the outcome.
    The second trade was with JDST, with the same layering strategy from mid January, to which I kept adding until February. I had an average of 21 and sold today at 22.
    Of course it was tough seeing JDST tumbling to 11.75 low, but the charts kept showing price going up on negative divergences and declining volume. Props to joefriday for staying the course on the same trade.
    I don’t advocate this method, but it can work. What I took away from these 2 trades is to time my entries better and wait for overbought or oversold conditions (if possible on the daily) to accompany divergences, although, as is the case with XBI, that also could take long to play out.

    1+

Leave A Comment