MarketWatch had a great article Friday in which Howard Gold discusses what he calls the “Worst Investment Ever.” He was talking about levered exchange-traded funds, the very popular segment of the ETF family.
These levered ETFs provide double and triple daily returns (or inverse returns) on the underlying index on which they are based. Investors have flocked to these instruments to the tune of $40 billion in assets. In my opinion, the majority of these assets are being used very incorrectly and to the detriment of the user.
The reason is these products are designed to replicate a multiple of the DAILY movement of the index. The ETFs themselves use futures to achieve the desired geared changes. Therefore, in order to provide double and triple the returns (positive and negative) on a daily basis, they are required to sell more futures on days the market is down and buy more futures when the market moves higher.
This process of chasing the market, buying high and selling low, causes a negative drift over time for the asset when the overall market is volatile. The problem is, investors are holding these for multiple days and even months.
Over time, with the ups and downs in the market, these products are designed to underperform. When looking at the pair of three-times levered ETFs on the financial sector over the past three months, many investors would expect if the bearish ETF (Direxion Daily Financial Bear 3x Shares – FAZ) were lower, the bullish ETF (Direxion Daily Financial Bull 3x Shares – FAS) would be higher. Not the case. FAZ is down over 20% and FAS is down over 30%!
Those investors who have held either of these ETFs have lost a significant percentage of their investment.
It is imperative for traders to remember these are designed to be intraday trading instruments, not a longer-term (or even shorter-term) hedge. The problem is the market can gap lower on the open, making it tempting to hold the inverse Bear ETF overnight in your position as part of a hedged position. Using put and put-spread strategies may be much more effective over time relative to owning a triple levered Bear ETF.
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I read an article this morning on CNBC.com about the 
1. Understand the equity markets. Options are derivatives, meaning they derive their prices from the prices of the stocks, ETFs and indexes they are listed on. While options strategies can limit risk or even change the risk you take, you should have some sort of opinion of the general direction of the particular security you are trading. Additionally, it’s probably good if you previously traded in the equity market. Market mechanics also play a role in how the options markets behave. Know where and how your stock trades, its volume patterns and any relevant fundamental data. Be aware of upcoming economic data being released, as macro data may also impact your trades. Also important to note is that options have multipliers; one options contract represents the right/obligation to buy or sell 100 shares of the underlying. Additionally, an option’s price also has a multiple of 100, so an option priced at $1.50 will in actuality cost $150 in your account.
Interest rates have moved lower recently due primarily to the financial scare across Europe. The two-year Treasury is yielding a paltry 87 bps. Even out 10 years, Treasuries are yielding about 3.25%. What is an income investor to do? Well, the recent sell-off in equities, accompanied by the expansion of implied volatility, has presented some interesting dividend yield plays.
