Direxion Daily Financial Bear 3X Shares (NYSE: FAZ) is probably the biggest go-to instrument for traders betting against the market because it offers triple-leverage in a bet against the financial stocks in the Russell 1000 Financial Services Index.  At 1:30 we have seen over 65 million shares trade hands and this 3X-leverage inverse ETF is up 10% at $25.55.  Average volume on most days is about 40 million, and now anyone who bought this one in the last 7 trading days is up.

The ‘slightly less bearish’ winner here is the UltraShort Financials ProShares (NYSE: SKF), which offers ‘only’ twice the inverse of the daily performance of the Dow Jones U.S. Financials index.  This has now seen over 25 million shares trade today and is up over 6% at $28.40 versus an average daily volume of roughly 29 million shares.

UltraShort S&P500 ProShares (NYSE: SDS) offers twice the inverse of the daily performance of the S&P 500 Index.  Shares are up 4% at $45.40 and its average volume of about 39 million shares should be eclipsed here in literally the next few minutes.

And then with oil busting under the $70.00 mark, you have the UltraShort Oil & Gas ProShares (NYSE: DUG) that offers twice the inverse of the daily performance of the Dow Jones U.S. Oil & Gas index.  This one is up 3.5% but ‘only’ on 5.2 million shares versus an average of over 8 million shares per day.

Think the housing and real estate recovery is bogus?  There is the UltraShort Real Estate ProShares (NYSE: SRS) that is up over 6% at $12.20 on over 24 million shares versus an average daily volume of about 29 million shares.  This one offers twice the inverse of the daily performance of the Dow Jones U.S. Real Estate index.

AIG, Vonage, Fannie and Freddie….. all were running like they were on steroids.  When there is a flight to junk, the contrarians are usually making their bets to go the other direction.  There are obviously many other inverse and inverse-leveraged ETF and ETN products.  But these have tended to be the most liquid or at least the most active ones.

As a reminder, these leverage and inverse-leverage ETF products often do not mirror their index levels.  But by now, even the pygmies know that.

JON C. OGG
SEPTEMBER 1, 2009

While this is not against any single leveraged ETF (or inverse ETF), it may have at least some influence on leveraged ETF and reverse-leveraged ETFs.  The two key ETFs for leverage and high volume and high volatility are the Direxion Daily Financial Bull 3X Shares (NYSE: FAS) and the Direxion Daily Financial Bear 3X Shares (NYSE: FAZ) as they are the triple-leverage financial sector ETFs.

A handful of the other active leveraged and inverse-leverage ETFSs are as follows: Ultra Financials ProShares (NYSE: UYG) seeks twice the daily performance of the Dow Jones U.S. Financials index.  UltraShort Financials ProShares (NYSE: SKF) seeks twice the inverse of the daily performance of the Dow Jones U.S. Financials index. UltraShort S&P500 ProShares (NYSE: SDS) seeks twice the inverse of the daily performance of the S&P 500 Index. Ultra S&P500 ProShares (NYSE: SSO) twice the daily performance of the S&P 500 Index.

Before you go out and worry too much about how many warnings are out there, the industry itself has been making more warnings of its own.  Direxion was either the first or one of the first to come out with a detailed analysis of how its ETFs have performed differently than the target index through time.  They have even engaged in a reverse stock split to curb some of the volume and volatility that is inherent with such low-priced stocks.  Direxion even warned how these are not to be held by long-term investors, so our own take on this is they have gone above and beyond their duty of warnings on how these act.

John Gannon, FINRA Senior Vice President for Investor Education: “Not all ETFs are created equal… leveraged and inverse ETFs can deviate substantially from the performance of the underlying benchmark…. that can turn into a minefield for buy-and-hold investors.”

The FINRA/SEC warning reminds investors that leveraged and inverse ETFs “pursue a range of investment strategies through the use of swaps, futures contracts and other derivative instruments.” It also notes that most leveraged and inverse ETFs reset daily as they strive to achieve the gain or loss performance on a daily basis.

The FINRA/SEC warnings also used the Direxion example of how the returns have differed through time.  The warning advises investors to consider these products only if they are confident the product can help meet their investment objectives and they are knowledgeable about and comfortable with the risks associated with these specialized ETFs.

In short, there is nothing different now about these products for active traders and day traders.  There is just a much deeper understanding by the public that 3X return goals might not generate a real 3X return through time.

JON C. OGG
August 19, 2009

This morning came an announcement from Morgan Stanley Smith Barney that it has placed certain restrictions on the sale of leveraged, inverse, and leveraged inverse exchange traded funds.  The reason even started out as “In response to concerns raised by regulators about these securities…”

The firm has noted that as of today, solicited purchases of these products will not be permitted in traditional brokerage accounts. Furthermore, it noted that unsolicited purchases in these accounts will be permitted only subject to enhanced oversight and review.  Lastly, the firm has noted that no purchases of these securities will be permitted in advisory accounts managed by Morgan Stanley Smith Barney Financial Advisors.

Morgan Stanley Smith Barney went on to note that Financial Advisors have also been encouraged to review existing positions in these securities with clients to emphasize their unique characteristics and risks.

We placed a call into the firm to see if this had become a large portion of the brokerage business in trading volumes, but the standard “we would not disclose that data” was all we got from the media relations.  It is hard to imagine that brokers and advisors of the firm would be actively pushing these leveraged and inverse-leverage ETFs to their clients regularly.  In fact, our take on this is that this is more of a “CYA” statement for internal purposes.  After all, this does not create an outright ban on these products.

What is interesting is that at least some of the managers of these ETFs have been vocal about the risks and have even demonstrated how through time these will not necessarily correlate to the exact or expected returns of the underlying indexes.  Direxion, in our opinion, gave one of the best disclosures that an ETF manager could give.  It said in a formal filing, “Particularly in periods of heightened volatility, the ETFs should be used by investors as short-term trading vehicles. As a consequence, we do not believe that investors should buy and hold the funds.”

With the inquiry from Massachusetts already out in the world of leveraged ETF products, we would expect more firms out there to adopt similar internal regulations or restrictions.  And the overall impact or effect it may have, that is probably minimal.

JON C. OGG
AUGUST 7, 2009

Ultra Financials ProShares (NYSE: UYG) seeks twice the daily performance of the Dow Jones U.S. Financials index.  UltraShort Financials ProShares (NYSE: SKF) seeks twice the inverse of the daily performance of the Dow Jones U.S. Financials index. UltraShort S&P500 ProShares (NYSE: SDS) seeks twice the inverse of the daily performance of the S&P 500 index. Ultra S&P500 ProShares (NYSE: SSO) twice the daily performance of the S&P 500 index.

There are many other issues from leveraged ETF families out there.  These are just some of the top leveraged exchange traded funds by trading volume.  But there are some considerations here that are a part of the Mass. Secretary of State inquiry.

As we noted before, Direxion specifically addressed several focal issues.  It has shown how returns differ from the target index and even went as far as saying these are not suitable investments for long-term investments.

We have confirmed with Direxion that Secretary Galvin has made an inquiry, but our contact also noted that the firm is cooperating with the inquiry and is very comfortable with all of their practices.  More specific details from the office of the Secretary of State have not been given to us as of yet.

What Secretary Galvin is probably looking to make sure of is that investors know what they are getting into, and that these funds are not being held by many widow and orphan funds.

We have essentially zero reason to expect any closure of these ETFs over this inquiry.  Nor do we expect these issues to have any bearing over the operations of these leveraged ETFs.  If anything, the inquiry would seem to lead to even more disclosure practices, and in the most extreme case it could possible create some ‘suitability issues’ that could make these exclusionary for certain types of investors and/or for certain retirement funds.

You can always join our open email distribution list to stay on top of key developments for ETFs and leveraged-ETFs, as well as keeping up with issues on key daily analyst calls, IPO’s, mergers, and other key events.

Update… CNBC has an interview with Secretary Galvin on this matter.
JON C. OGG
July 15, 2009

Direxion just announced a reverse split for another ETF yesterday, but not its two financial triple-leverage ETFs.  Direxion Daily Financial Bull 3X Shares (NYSE: FAS) is now back down close to $8.00 per share, yet it trades 250 million shares on an average day.  The Direxion Daily Financial Bear 3X Shares (NYSE: FAZ) is barely above $5.00 and trades more than 200 million shares on an average day.  So between the FAS and FAZ, you have an average of more than 450 million shares, and at today’s prices that is close to $3 billion worth of nominal value.

This review discusses a portion of the ETFs and ETNs and the ones under discussion today, along with underlying key companies, are Ultra Financials ProShares (NYSE: UYG), Bank of America Corporation (NYSE: BAC), B2B Internet HOLDRs (AMEX: BHH), Ariba, Inc. (NASDAQ: ARBA), Internet Capital Group (NASDAQ: ICGE), Internet Infrastructure HOLDRs (AMEX: IIH), VeriSign Inc. (NASDAQ: VRSN), Akamai Technologies Inc. (NASDAQ: AKAM), United States Natural Gas (NYSE: UNG), United States Oil (NYSE: USO), SPDR Gold Shares (NYSE: GLD), UltraShort S&P500 ProShares (NYSE: SDS), SPDRs (NYSE: SPY), New York Stock Exchange (NYSE: NYX) and the NASDAQ OMX Group Inc. (NASDAQ: NDAQ).

Ultra ETFs…

Ultra Financials ProShares (NYSE: UYG) is another low-priced active ETF.  Its seeks twice the daily performance of the Dow Jones U.S. Financials index, and normally invests 80% of the fund’s assets in financial instruments with economic characteristics that should be twice the return of the index.  With a trading range of $1.37 to $25.03 over the last year, it is easy to see where the volatility can go.  This trades nearly 100 million shares on average, yet its price is $3.65 after a 2.5% gain.

Merrill Lynch HOLDRs

Now that Bank of America Corporation (NYSE: BAC) owns Merrill Lynch, it is time for it to clean house on at least two of the HOLDRs family of ETFs.  HOLDRs are hybrd ETFs that gave investors a chance to individually own shares directly in underlying stocks. Based on how much direct mail was sent out just a year or two ago on the Semiconductor HOLDRs, B of A could save everyone some serious money by not having to send out that proxy and annual report material to holders of each stock. Let alone a headache.

The B2B Internet HOLDRs (AMEX: BHH) is an old legacy ETF that should just go away.  While it trades over 30,000 shares on average, it is deep into penny-stock territory.  Now that its last major constituent was acquired, Ariba, Inc. (NASDAQ: ARBA) and Internet Capital Group (NASDAQ: ICGE) are the only two holdings left.  Maybe this is just for pairs trading on days when Ariba has big news.

Internet Infrastructure HOLDRs (AMEX: IIH) is another one of the old legacy ETFs from the Internet Bubble days that went from active and high priced to micro-cap and generally thin volume.  Of course the 266,000 shares around noon is a slap in the face against the argument today, but this frequently sees less than 10,000 shares.  The page for the weighting also has over 82% of the entire ETF weighting as being only two stocks: VeriSign Inc. (NASDAQ: VRSN) with 55.76% and Akamai Technologies Inc. (NASDAQ: AKAM) having 27.9%.

ETFs and ETNs in Commodities….

There are two funds which track energy commodity prices, and these ETFs have actually been accused of manipulating the price of underlying commodities.  Jim Cramer recently blasted the United States Natural Gas (NYSE: UNG) fund.  He said this one has actually become large enough because it gave traders a chance to buy big enough quantity of natural gas that he thinks the fun ran up prices because it invests almost entirely in near-month natural gas futures contracts.  If that gets $100 million in buy orders for the ETF, that goes directly into the natural gas futures market.

A similar situation was noted earlier this year and last year during the oil boom and bust: the United States Oil (NYSE: USO) ETF is meant to track the spot price of West Texas Intermediate light sweet crude oil.  Yet during the boom and bust of oil, futures traders were able to game the “USO” because of its order flows and high demand followed by an exodus.  Whether or not this one is responsible for running up or running down the commodity is something that will never be proven.  How many speculators told Congress that speculators were not responsible for the run-up in crude last year?  Sometimes the answers are obvious, but are not easy to quantify.

And the beloved gold ETF the SPDR Gold Shares (NYSE: GLD) has good intentions too.  But it goes out and purchases direct bullion and exchange baskets.  This ETF is so large that it is still said to be among the top 10 holders in entire gold reserves.

In commodities, it would seem that FINRA might consider making some of these trade as closed-end funds with limits to size in relation to the entire market of the underlying commodity.  That is not likely to occur, but it is a thought.  If inflation ever gets too heated, don’t be too shocked if and when you see a sudden Congressional press or or a FINRA-led press to stop inflows from making the commodity prices move solely be ETF owners buying more and more.

Two S&P ETFs That Do Work…

The UltraShort S&P500 ProShares (NYSE: SDS) against the SPDRs (NYSE: SPY) is an example of a pair of an inverse ETF and corresponding long ETF that actually work the way these were meant to work.  The SDS trades 45 million shares on average and that is over $2 billion worth of nominal value.  It is technically twice the inverse performance of the S&P 500 Index.  The “Spies” trade about 275 million shares a day, yet the price is nearly $90.00 (one-tenth of S&P).  That is over $24 billion worth of stock in nominal value.  Compare this dollar volume daily to that of the FAS and FAZ.

Other Issues to Consider

There is another notion here to consider, and that is the New York Stock Exchange (NYSE: NYX) and the NASDAQ OMX Group Inc. (NASDAQ: NDAQ).  Both major exchanges have relaxed the old absolute guidelines on the $1.00 rule.  There are many stocks that fell under $1.00 that are just too active in trading volume.  Booting those funds off the exchange because of the numbers of stocks they own and because of the number of shares would be the exchanges intentionally cutting off some of their own trading volume business.  How many operating businesses want to intentionally choke their own business and income streams?  Yep, not many.

It is impossible to say whether or not a reverse split would make a huge difference in the volatility of low-priced ETFs.  You could even make a case that if the prices were adjusted higher via a reverse stock split that the underlying ETFs would see more volatile price moves as each penny is worth less and less on a percentage basis.  For a $5.00 stock, each penny up or down is 0.20% and that is before any commissions are applied.

There are other risks here if ETFs are allowed to grow indefinitely.  Imagine if the entire world decided to trade ETFs rather than ever invest in individual stocks.  This would make the money flows of an ETF determine the direction of a stock.  Imagine if a company was small and attractive, but was not part of any ETF.  That company would be public, yet effectively shut out of the market.

This list of questionable ETF and ETN investment is actually far longer than just these mentioned today.  We will be following up with each of these individually over the next week or two by fund family and/or by asset class.  You can also learn more about these via subscribing to our open email distribution list.

Jon C. Ogg
June 23, 2009

The S&P 500 has a 50-day moving average of 900.79 and the 200-day moving average is 898.72.  After a drop of 24 points to 897.15, this puts both the 50 and 200 day moving averages front and center. This is also being confirmed in the SPDRs (NYSE: SPY) at $89.82 with a 50-day moving average of $90.12 and a 200-day moving average of $89.49.  Those two moving averages crossed late last week.

With this coming on the same week as an FOMC meeting and when traders feel the market got too far ahead of itself, these charts are going to be crucial compared to a few weeks ago.  We have provided two charts from StockCharts.com below to show an example of these key moving average alerts:

And if you want the volatile of the volatile, then you always have the ProShares Ultra Short S&P 500 ETF (NYSE: SDS).  The moving averages on the leveraged ETF’s, particularly the inverse ETF’s, are questionable as to whether they can be relied upon.

-Jon C. Ogg

This new stimulus package is going to help keep things afloat a bit and the new mortgage cap lifting along with lower mortgage rates will allow many homeowners to refinance.  But there are still going to be many more credit blow-ups, more house foreclosures, more cars repossessed, more credit card defaults, more delinquent payments, slower retail sales, more bankruptcies, and probably fewer jobs.   

We can’t predict where the market will be at the end of the year and can’t predict how bad the economy will really get.  We may have a softer landing than it was looking just last week, but it is still going to feel like a thud or a hard landing if not worse to many individuals and many businesses.  We’ll be the first to admit that with many in the media covering "Bear Markets" may already mean that the worst has been seen.  Many argue that long-term investors and value investors want to start buying stocks in a recession because if you wait for the good news to come in you might have already missed the boat.

247WallSt.com wanted to compile a list of "Inverse ETF"s" that are actually designed to go up in a down market.  This is in a sense the same thing as short selling without having to understand the metrics and rules of short selling.  In essence, these are the easiest transactions to make for novice investors and sophisticated fund managers alike.

ProShares has created ETF’s that trade inversely with the markets.  These are aimed to allow investors and traders to hedge against market downturns or that want to profit from a market decline.  These ETFs are very liquid and actively traded and are designed to go up when indexes go down.  As a reminder, the SHORT funds use no leverage, but the UltraShort funds employ leverage.  Here is that list by Fund (Ticker):

• Short QQQ (AMEX: PSQ)    
• Short Dow30 (AMEX: DOG)    
• Short S&P500 (AMEX: SH)    
• Short MidCap400 (AMEX: MYY)    
• Short SmallCap600 (AMEX: SBB)    
• Short Russell2000 (AMEX: RWM)    
• UltraShort QQQ (AMEX: QID)    
• UltraShort Dow30 (AMEX: DXD)   
• UltraShort S&P500 (AMEX: SDS)    
• UltraShort MidCap400 (AMEX: MZZ)   
• UltraShort SmallCap600 (AMEX: SDD)   
• UltraShort Russell2000 (AMEX: TWM)
• UltraShort FTSE/Xinhua China 25 (AMEX: FXP)… short selling the Chinese Stocks.

Rydex Funds was perhaps the first of the mutual fund operators that actually had the inverse of the S&P called the Rydex Ursa Fund, now called the Rydex Inverse S&P 500 Strategy Inv (RYURX).  As Rydex saw the importance and rise of ETF’s, it combined its open-ended fund management operations into one that now has ETF’s for traders as well.  Here are its inverse funds:

• Rydex Inverse 2x S&P 500 (AMEX: RSW)
• Rydex Inverse 2x S&P MidCap 400 (AMEX: RMS)
• Rydex Inverse 2x Russell 2000 (AMEX: RRZ)

These are not all of the ETF’s out there.  But these are two of the fund families we have seen that have liquidity and recognition in the sector.  Stay tuned to our ETF news as we are expanding this into a new branch.  We’ll also be covering certain defensive strategy ETF’s that use covered call option strategies, value investing strategies, and some that focus on defensive strategies.

Jon C. Ogg
January 27, 2008

What’s an easy way to tell when the market had a pretty bad hair day, other than looking at the ticker tape?  Seeing that all of the ETF winners for the day are listed as the UltraShort "Whatever" ProShares……they are the inverse move of an any underlying index, so when they are up the index or the market is down.  The top 12 performers today were all in that category. Some of these are leveraged to their index, not it doesn’t mean the worst performers are the underlying index per se.

UltraShort Real Estate ProShares (SRS) 3.52%   
UltraShort Utilities ProShares (SDP) 3.13%   
UltraShort Semiconductor ProShares (SSG) 2.09%
UltraShort Russell2000 Value ProShares (SJH) 1.66%
UltraShort Consumer Goods ProShares (SZK) 1.59%
UltraShort SmallCap600 ProShares (SDD) 1.49%
UltraShort Russell2000 Growth ProShares (SKK) 1.41%   
UltraShort Financials ProShares    (SKF) 1.36%
UltraShort S&P500 ProShares (SDS) 1.35%
UltraShort Consumer Services ProShares (SCC) 1.24%
UltraShort Russell MidCap Val ProShares    (SJL) 1.20%   
UltraShort Russell2000 ProShares (TWM) 1.06%

Other non-short ETF winners:
iShares FTSE/Xinhua China 25 Index (FXI) +1.02%
PowerShares Gldn Dragon Halter USX China (PGJ) +0.80%
HealthShares Cardiology    (HRD) +0.7%

Worse non-Ultra funds today:
Internet Infrastructure HOLDRs (IIH) -1.82%
DJ Wilshire REIT ETF (RWR) -1.76%
iShares Cohen & Steers Realty Majors (ICF) -1.76%   
iShares Dow Jones US Home Construction (ITB) -1.64%
iShares MSCI South Africa Index    (EZA) -1.60%
United States Natural Gas (UNG)    -1.55%

Today was more of a Bernake playing hankie with words than it was China.  Tomorrow’s another day.

DJIA                       13,595.46; -80.86 (0.59%)
NASDAQ               2,611.23; -7.06 (0.27%)
S&P500                1,530.95; -8.23 (0.53%)
10YR-Bond          4.9760%; +0.0470%
NYSE Volume      2,884,657,000
NASDAQ Volume 2,233,690,000

Jon C. Ogg
June 5, 2007