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

• Bank of America (NYSE: BAC) was listed as some $2.217474 billion stake via 167,990,464 shares.
• Capital One Financial Corp. (NYSE: COF) was listed as $371.960 million via a stake of 17,000,000 shares of common stock.
• Fifth Third Bancorp (NASDAQ: FITB) was listed as $35.5 million via a 5,000,000 share stake.
• First Horizon National Corp. (NYSE: FHN) was listed as $36 million via stake of 3,000,000 shares of common stock.
• Goldman Sachs Group Inc. (NYSE: GS) was listed as $294.88 million via a stake of some 2,000,000 shares of common stock.
• JPMorgan Chase & Co. (NYSE: JPM) was listed as $238.77 million via a stake of 7,000,000 shares of common stock.
• Marshall & Ilsley Corp. (NYSE: MI) was listed as $57.6 million via a stake of 12,000,000 shares of common stock.
• People’s United Financial Inc. (NASDAQ: PBCT) was listed as $41.443 million via stake of 2,750,000 shares of common stock.
• Ultrashort Financial ProShars (NYSE: SKF) was listed as $83.58 million via some 2,000,000 shares.
• Regions Financial Corp. (NYSE: RF) was listed as $141.4 million via a stake of 35,000,000 shares of common stock.
• State Street Corp. (NYSE: STT) was listed as $33.04 million via a stake of 700,000 shares of common stock.
• Suntrust Bank Inc. (NYSE: STI) was listed as $24.675 million via a stake of 1,500,000 shares of common stock.

The FULL SEC FILING is here, and there are many non-financial stocks in there.

JON C. OGG
AUGUST 12, 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

The PowerShares Financial Preferred (NYSE: PGF) is the ETF that specifically tracks the preferred shares of financial stocks.  This can also be impacted, although we would note that this ETF here has five of its top ten holdings which are European bank preferred shares and the top ten holdings are over half of the ETF.

This comes on the hells of this morning’s Bank of America Corporation (NYSE: BAC) announcement that it was offering a tender exchange offer on nine of its preferred series for up to 200 million shares of common stock.  At today’s prices, that would represent more than $2.2 billion in new common stock.  The largest US bank holding company issuers we have seen with Bank of America are JPMorgan Chase & Co. (NYSE: JPM), Wells Fargo & Co. (NYSE: WFC), and Goldman Sachs Group Inc. (NYSE: GS).

We have already seen some selective retirement of preferred stock from the likes of Citigroup, Inc. (NYSE: C), and that accomplished some of the same issues that Bank of America was trying to address.

All of these index levels actually track just the common stock, so the dilution, the new issuances, and the potentially larger market caps of the common shares would be what matters to these ETF’s.  These ETF’s are only full of the common stocks.

The biggest issue out there for how this will affect the ETF’s which track banks, financials, and preferred shares is the overall weighting.  If B of A is successful at this, we could easily see other banks following suit.  JPMorgan CEO Jamie Dimon already bought preferred shares.

The incentive here is actually rather simple to retire these at lower prices than the traditional $25.00 PAR if possible.  The yields on many of these preferred securities is close to 10%.  Some yields are even higher.  Bankers cannot make that much spread even if the credit card rules were not changing.

There is also the notion that these preferred share redemptions act as effective Tier-1 capital raising activities.  Some consider this a balance sheet trick, but if it lowers current obligations and long-term debt then that is ultimately good for shareholders of common stock in today’s environment even if you consider the dilution that the common holders have to accept.

JON C. OGG
May 28, 2009

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