3x Leveraged ETFs Throw Rocket Fuel on the Fire
These ETFs are designed for sophisticated investors and should come with a warning label.
Market-timers rejoice! Today, Boston-based Direxion officially launched the first group of exchange-traded funds that offer triple leverage, or 300% exposure to market indexes to make bullish or bearish bets. With excessive financial leverage at the heart of the current credit crises, the timing of this launch may surprise some. Over the past several months market participants have experienced unprecedented levels of volatility. With a dynamic regulatory environment, blitzes of weak economic data, credit markets that have yet to fully thaw, and uncertainty surrounding the new administration, it seems as though volatility may remain for some time. For investors looking to magnify market returns with these aggressive products, we can offer some simple advice: Hold on to your hats.
In all seriousness, we do think that these 300% leveraged ETFs can be powerful and effective tools to speculate on the market's daily movements--if used properly. However, they can also be very detrimental to an investor's financial health if used without caution. In our view, these products should be viewed as hedging and speculation tools that are better suited for use by professional investors. For instance, an institutional investor seeking to hedge his exposure to oil could theoretically do so by using one third of the capital. The investor could then deploy the extra capital afforded to him by the 300% in other investment opportunities. The leveraged inverse ETFs can make sense from a risk management perspective as well: An investor can't lose more than his or her initial investment with these products, while in a traditional short position one would theoretically be exposed to unlimited losses.
John Gabriel has a position in the following securities mentioned above: BRK.B. Find out about Morningstar’s editorial policies.