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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We talked about “Expiration Week Earnings Plays” in this week’s webinar (you can access an archived version from this link or peruse our webinar archive page).  During the session, we highlighted what the option market was projecting about the expected move in companies such as JPMorgan Chase (JPM) and Google (GOOG).

At the time of the webinar (after Tuesday’s close), at-the-money straddles were indicating a 3.2% move in JPM and a 4.4% move in Google through today’s expiration.  Remember a straddle is the simultaneous purchase (or sale) of the call and put with the same strikes (and same expiration). Adding the at-the-money call and put prices together is a reasonable reflection of the option market’s expected move for the underlying through the next expiration date at any given time. Continue Reading

This week marks the final days that Citibank will be trading below $5 per share (or even $20 per share) for some time!  This is not due to the business getting remarkably better and the prospects for the shares becoming suddenly bullish.

Rather, the company will be going through what is known as a reverse split of their shares.  The previously announced 10-for-1 reverse split will  take place this weekend with the shares trading ex-this split Monday morning.  What this means for the typical investor is if they held 1,000 shares of C stock, on Monday morning they will have only a 100-share position.

Investors are not economically disadvantaged as the stock’s trading price will likely be around $45.20, up from the current $4.52 due to the fact that the company is the same size but there are 1/10^th the number of shares outstanding. Continue Reading

About 18 months ago – On October 20, 2009, to be specific – I posed the question, “Is it Time to Re-Weight the Nasdaq 100?”* At that time, Apple (NASDAQ:AAPL) shares had a 15.6% weighting in the 100-stock index (and by default, the Nasdaq-100 Trust).

At the time, I noted:

“…the relative outperformance of Apple (AAPL) shares in the past six years has created a situation that may be a call to action by the owner of the index, Standard & Poor’s, to re-weight Apple shares in the index as Apple has now become the 1000-pound gorilla … S&P may see the need to reduce the Apple weighting in the NDX and the related exchange traded fund … to equalize the components. If this happens, indexers will be forced to lighten the number of shares they hold in Apple stock. So in essence, Apple could theoretically be penalized for its own success.”

In the ensuing 18 months – as Apple’s stock price rose from $200 to around $340 – its weighting in the index grew as well, moving to 20.5%. While the iPhone parent’s market cap has swelled to twice that of Google (NASDAQ:GOOG), its weighing in the NDX is now five times as great. Continue Reading

The broad market took it on the chin yesterday, losing around 1.5%, and Alcoa (AA) was among the worst-performing names in the Dow, shedding more than 3% of its value. The aluminum company’s CEO said Tuesday that while U.S. industrial demand for the metal is improving, he doesn’t feel “the current environment is such that [Alcoa] want[s] to bring capacity back” to pre-recession levels.

Some traders seem to have viewed pullback as a buying opportunity. Two large blocks traded on in-the-money, intermediate-term calls during Tuesday’s session. Continue Reading

Yum! Brands (NYSE:YUM) is looking to shed two of its less-iconic brands (Long John Silver’s and A&W) but a long-term investor seems to be adding to his or her own bearish position by scooping up LEAP ratio put spreads. The January 2013 40 and 45 puts were active on Monday and it was the second time since late January we have noticed unusually large volume at these strikes.

Yesterday, as the stock was moving modestly higher to an eventual close of $50.30, an investor apparently sold 3,600 of the January 2013 40 puts, as they traded on the bid price of $3.00 apiece.  At the same time, a block of 2,000 of the January 45 puts traded on the ask price of $5.00 each, suggesting they were initiated on the buy side.  This spread likely traded with stock, but probably only to aid in its execution.

What is especially interesting about this trade is not even the long-term nature of the play or the 1.8 ratio at which it traded, but the fact that the same strikes saw similar action on January 27.  On this day, it looks as though 8,000 of the 40 puts sold for $3.70 each while 5,000 of the 45 puts were bought for $5.90 each.  If it is the same investor, they may just be adding to this position with a similar trade fewer than three weeks later. Continue Reading

While dire weather forecasts may have sent anxious shoppers to Costco (NASDAQ:COST) to stock up on non-perishables, paper goods, and booze, an investor apparently took a bearish stance on the warehouse-style retailer in Wednesday’s trading. Specifically, the March 70 put saw more than 26,000 contracts trade versus open interest of 145 contracts. The stock popped up on the list of put/call ratio leaders, as more than 31,000 puts traded across all option series compared to roughly 2,500 calls.

The lion’s share of today’s option volume on the March 70 put – 19,490 contracts, to be specific – traded in one block around 10:20 a.m. Central Time.  This trade crossed the tape at $1.13 apiece, which was the ask price at the time. Trading on the offer price suggests the puts were opened on the buy side, most likely by traders with a bearish outlook on the stock.  The entire block cost $2.2 million in premium for the investor in question. Continue Reading

Dow component Exxon Mobil (NYSE:XOM) saw some unusual option activity Tuesday as some option investors appear to have sold January 2012 80 calls (expiring in just under a year) and bought January 2013 90 calls (expiring in just under two years). Wednesday morning’s open-interest translations suggest the 2013 calls traded to open (open interest rose from 473 contracts to nearly 17,000) the picture of the 2012 80 strike suggests that these were likely sold to close.

After seeing volume of more than 15,000 contracts trade on Tuesday, open interest dipped to 27,480 from 35,255 yesterday morning.  It’s likely, therefore, that the seller of these calls traded to close but some of the contracts were scooped up by other traders buying to open. This would account for an “unchanged” open interest for some of the contracts in question. Continue Reading

Today is monthly options expiration, and trading volumes tend to build in the days (and hours) leading up to the session’s close. Investors holding options have to decide whether to close their options, let them expire, or roll them to a later month.

Now is a good time to remind you of the inherent risks associated with automatic expiration. Long call options that are in-the-money at expiration – EVEN by JUST a penny or more – will automatically become that stock holding. This can be difficult for investors who a) didn’t really want to own the stock or who b) don’t have the money to buy the stock. And “difficult” can become “horrible” if the stock were, for example, to gap lower out of the gate on Monday. For a more in-depth look at this concept, check out George’s article, Automatic Exercise, After-Hours Risk, and Other Options Expiration Issues. Continue Reading

If the recent influx of put activity is any indication, bearish traders are flashing their teeth in eBay (NASDAQ:EBAY) ahead of the online auctioneer’s earnings report after today’s close. BusinessWeek reported that the ratio of outstanding puts versus calls rose to 1.23 from 1 last week, hitting its highest point since July 2003.

Analysts, on the other hand, appear to be skewing bullishly. The consensus earnings estimate stands at 47 cents per share, marking a three-cent improvement over year-ago levels.  What’s more, according to Bloomberg, only one of the 35 analysts covering the shares rates it a “sell,” with 15 naming EBAY a “buy.”

Continue Reading