The SEC Should Listen to Expert Traders in 4X ETF Case
The vast majority of people who tell you not to invest in leveraged and inverse exchange-traded funds have never owned or traded one.
But in the current discussion over whether the Securities and Exchange Commission should approve two new ETFs seeking to quadruple the daily return of the U.S. stock markets – a move that critics say would open the door to even more highly leveraged products – the lack of trading experience translates to a lack of understanding.
Until recently, I would have been in the just-say-no camp for leveraged and inverse ETFs. They always seemed to me like illegal drugs, where I understand the side effects and impacts and can accurately discuss the downsides without ever having partaken myself. And no, I have never even sniffed at a leveraged ETF.
Since recently joining RagingBull.com as editor, however, I have watched expert traders use leveraged ETFs like an art form, finding ways to gain an edge and make money on days when the market has been mostly flat and lacking volatility.
What’s more, these traders aren’t using leveraged ETFs in the ways that make them bad on paper. They’re not acting like a badly addicted gambler trying to double down in a casino.
So when I see the SEC reconsidering its approval of the new ultra-leveraged ETFs, I wonder whether the agency and the critics are protecting the public from a real danger, or trying to protect investors from themselves.
Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track; if the Russell 1000 Financial Services Index gains 1 percent in a day, for example, the Direxion Daily Financial Bull 3x Shares (FAS) should deliver roughly 3 percent.
Inverse ETFs or short funds move in the opposite direction from the benchmark they track, and leveraged-inverse ETFs ("ultra short" funds) try to do that in multiples. Thus, if the Standard & Poor’s 500 falls 1 percent in a day, the ProShares UltraShort S&P 500 ETF (SDS) would be up roughly 2 percent.
It’s confusing, especially because investors miss out on the fact that the funds are pegged to daily returns. When held for longer than a day at a time, your mileage may vary, because the time decay on the options needed to create these funds comes into play and takes a bite out of the numbers.
There are now over 200 leveraged ETFs holding almost $45 billion in assets, meaning investors can play hunches in everything from single countries like Brazil to commodities like gold to industries like energy and everything in between.
They can also get burned by the math if they hold on too long waiting for their hunch to pay off.
That’s one reason why last year the SEC proposed rules limiting the use of derivatives and leverage in mutual funds and ETFs, a move that could kill off new issues if not the entire category.
When the SEC in May approved the ForceShares Daily 4X US Market Futures ETFs – which come in long and short flavors, each betting on financial contracts with returns tied to the S&P 500 and trying to deliver returns four times the daily performance of those futures – it appeared that any move to rein in leveraged funds was over.
Shortly thereafter, however, the SEC reconsidered its approval; currently, the launch of the new funds is stalled.
The same experts who have never traded these products called that a triumph and a return to common sense.
When I re-read the SEC’s investor alert about leveraged and inverse ETFs, it was clear that they were issuing a warning to buy-and-hold investors – completely unsuited for these products – rather than for people who might trade them.
Leveraged products are power tools. The traders I talk with each day are looking at charts and analytics for specific entry and exit points, they’re putting stop-losses in place, they’ve calculated a risk-reward ratio that is in their favor, and they are on top of the trade minute-by-minute. They use leveraged funds leverage to squeeze more out of small, quick moves lasting a few days at most, and use ordinary index ETFs when they see something big and long-term.
If you’re playing a hunch with a leveraged ETF rather than trading a strategy based on strategic analysis, you’re the dumb money at the table.
The problem at that point isn’t with the leveraged or inverse ETF, it’s with you.
I’m not sure regulators can or should protect investors from their own stupidity.
The argument against approving the new ETFs and expanding leverage, therefore, shouldn’t come from folks who have never traded them, but from people with skin in the game.
Here’s where I was surprised. Expert traders don’t think these products are necessary; if they want to protect the public from mishandling new products – and they do -- that speaks volumes.
Jeff Bishop of TopStockPicks.com acknowledges that he would use the FocusShares products – once approved, opened and showing sufficient liquidity – for the extra leverage, but noted that “4x products are just a bad idea in general. There's no true investment reason why they should exist; it is just for day-trading junkies.”
Most people, Bishop noted, won’t use the new products the way he does. “They’ll buy-and-hold them for way too long. These 4x products, if approved, are going to cause a lot of unsuspecting people a lot of pain.”
NBA Player Carl Landry Demonstrates the Value of Persistence in Life and Work
Written by: Jon Sabes
When you meet Carl Landry, stand-out college basketball player and nine-year NBA player, you imagine that becoming a professional basketball star was a straight forward run for the 6-foot-nine-inch power forward.
However, when you go deeper into Carl’s background, becoming a NBA professional was less than certain and little came easily to the 33-year-old from Milwaukee:
- He was cut from his high school team as a freshman and averaged less than ten points a game when he did play as a senior.
- He started his college career not at Purdue, but a junior college where it was not clear he would play.
- When he finally got to Purdue, he tore his ACL in his knee his first year and reinjured it the next year.
- While his family held a party for him the night of the NBA draft, he slept in the Philadelphia airport after missing a flight following a workout for the 76ers.
- In the NBA playoffs, Carl had a tooth knocked out, but came back in the same game to make a game-winning blocked shot as the Rockets beat the Utah Jazz 94-92.
Landry, who I interviewed on my podcast, Innovating Life with Jon Sabes (www.jonsabes.com), is a remarkable example of the value of “persistence.” In a time where technology creates the image that anything is possible at the touch of a button, persistence is an under-appreciated trait. When I spoke with Carl, I clearly saw someone for whom success has only come through a force of will that made him a NBA player, but it also made him a better player every year he played. That’s the kind of personality that has produced greatness in business as well as sports.
Carl was, in fact, drafted that night he spent in the airport. The Seattle Supersonics chose him as the 31st overall pick and then traded him to the Houston Rockets where he rode the bench for much of the first half of the season. When All-Star teammate Yao Ming was injured, he stepped in and played a key role in the Rockets astonishing 22-game winning streak (the third longest streak in NBA history). And, that season, after sitting on the bench for 33 of the first 36 games, he was named to the All-Rookie second team.
Carl was the first in his family to go to college. “I told myself that this was my ticket out, so I did everything I possibly could to be the best person in school and also on the court,” he said.
His family life in Milwaukee showed him what he didn’t want to do. “Just being honest with you, seeing some my cousins, peers, they went to work for jobs paying six, seven dollars an hour or they didn’t go to work at all and then living off welfare. I didn’t want that.”
When he was first injured, he had to contemplate the end of a career before it even got started. “When you have an ACL tear, it’s over…no more basketball,” he told me. “I said, God, give me health again and I’ll do everything I can to leave it all out on the line and be a successful individual.”
On my podcast, Carl pointed out another interesting lesson he learned in the NBA: Not doing things just to fit in.
“Fitting in was easy,” he said. “Doing everything that everybody else does was easy. If I stood out in some type of way, I’m going to have different results. I’m going to have stand-out results.”
That’s called the “Law of Contrast” and it produces that exact effect of changing the outcomes that everyone else is experiencing. Carl is smart, he recognized that differences make a difference, and doing whatever it takes is what is required to make real, meaningful differences.
Every off-season for the last 11 years, he has run a camp for kids in Milwaukee where he tells youth his story of hard work and persistence. “I always tell the kids to apply themselves and always be persistent,” he said. “If you dream, apply yourself and be persistent. With hard work, man, the sky’s the limit.”
When Carl says the sky’s the limit he means it. He is smart to recognize that it’s important to dream big, because if we don’t – we may be selling ourselves short. “You have to dream bigger than your mind could ever imagine,” he said. “I wanted a nice house. I wanted a nice car. I said, and I got all of that. So, what do I do, do I stop now? Maybe I didn’t dream big enough.” That’s a big statement coming from a kid who grew up to be the first in his family to graduate college and go on to be not only a top NBA basketball start, but a good businessman, father and someone who gives back to the community.
I’m convinced that in whatever he takes on as a basketball player or in his post-hoops career, Carl Landry is not going to stop getting better at whatever he does, and in the process of doing so, make the world a better place.
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