Friday, February 27, 2009

Stay Away from 2X ETFs, Cause and Effect Relationships

Here are the total daily dollar amounts traded as of yesterday in the financial 2X and 3X ETFs:

SKF: $5.1B
FZA: $1.3B

XLF: $2.0B

The volume on UYG ($370M) and FAS ($800M) is small or negligible compared to these.

The SKF and FZA issuers must hedge themselves by shorting stock or using other instruments like CDS. They absolutely have to do it or risk going bankrupt. The effects are obvious on the underlying stock prices.

When those SKF holders start stampeding out, watch out above. All the shorting must be covered. You may see the mother of all rallies.

For similar cause-effect reasons to the downside, it is possible that these 2X derivatives to be outlawed. In fact, a great rally would occur by doing so, except for the ETFs themselves which would drop to $0.

Buying these is like playing with fire. Fire can burn and hurt badly!

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reboot said...

nice blog. very informative; especially about staying away from certain the ETFs. checking out your straddle strategy to see if it works with hypothetical trades.

The Shocked Investor said...

Thank you "reboot". Paper trading is the best to start with. Try several of them. The hard part is choosing when to sell. Usually the easiest is to have a pre-defined exit profit threshold and/or stop losses, i.e., sell when you achieve +10% (or whatever you choose), or sell if you go down -30%, for example.

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