Raising Lazarus, the Leveraged ETF Investor ~ The Risk Averse Alert

Saturday, June 20, 2009

Raising Lazarus, the Leveraged ETF Investor



This past week reader J.R. (neither of "Dallas" fame nor to my knowledge the former NFL coach) sent me an article you might be interested in reading. The subject involves an issue you may not be familiar with.

J.R. was alarmed by what he learned, saying...


"Tom....this one is right up your ally. It will seem crazy at first but I need your undivided attention on this very detailed explanation. Perhaps, Cramer may have a point as to why SKF doesn't quite do what it's supposed to. Worse, it does do what it's supposed to, just not what we thought it is supposed to do. Crazy stuff here, but a seemingly educated and well done case against ETFs, especially Ultra ETFs.?"


Here's the article. I recommend you read it...



Now, I was aware of the risks the author raises. Yet since you might not be, and because the author does a nice job of explaining the matter simply, I wanted to pass this along.

Let me also share my reply...
I am familiar with the risk presented in the article you forwarded. And I accept this risk. I appreciate the fact that, "you are almost mathematically guaranteed to get a return that is not double that of the index" with ProShares 2x fund positions held for any period of time. Nevertheless, with a reasonable degree of correct timing over some relatively short-term duration you still can do better than the underlying index. Even when I was wrongly positioned earlier this year (Jan - Mar), the market's subsequent recovery brought my position back to the point where the loss I suffered was acceptable. Had I held the position a little longer I would have suffered no loss at all.

Cramer definitely has a point regarding SKF. It is the same point the author makes. However, does this mean they should be banned? I rather think Cramer is talking Wall Street's book (particularly Goldman's). He believes these leveraged ETFs punish what are otherwise good stocks. Contrarily, I believe most of the stocks in XLF (GS included) are grotesquely leveraged pigs waiting to be slaughtered. To blame the SKF for the recent travails of these companies is just plain ludicrous.

Can't say any valuable lesson was learned from my experience being on the wrong side of the [leveraged ETF] trade earlier this year ... other than that some significant portion of long equity players who were still positive at year-end '08 probably should have been expected to lock in their [reduced] profits at the start of the year. I should have foreseen this and not have been so quick to think the recovery we saw post-March bottom might come sooner. Unfortunately, the thought of "profit taking" at the start of the year never crossed my mind. Nevertheless, that recovery did come as anticipated proved the savior of my position. Since this is what I believed would happen, I did not panic out of my position late-February, early-March, despite the fact it was getting clobbered.

I think the underlying stance many leveraged ETF commentators have toward "market timing" submits to belief that such endeavoring is an exercise in futility. Of course, at some level I would agree with this. However, as an overriding theme of one's investment philosophy I reject the notion that mass psychology is entirely chaotic and indiscernable. Investing is one place where humanity's tendency to behave like lemmings is reasonably quantifiable.

Not sure if any of this helps answer the question you might have about whether I actually know what I am doing, or whether I am running on luck. To be perfectly honest it's a little of both. I suspect that, even Warren Buffett would confess the same at some level. That said, though, I do not suppose I could have matched his performance over the past 40 years were I his age. Then again, past performance is not indicative of future results and it is quite possible Mr. Buffett's unswerving faith in American capitalism might be put to the test straight ahead.

Quite the windbag, aren't I?

Anyway, my observation about "profit taking" at the start of the year was something I have been wanting to write about. Profit taking is not something you would expect following last year's unraveling. However, fear being a very powerful emotion and U.S. tax law working off the calendar year, selling at the start of the year originating from players fearing full loss of long-term capital gains makes a lot of sense.

And once this got under way, then came the lemmings...

* * * * *

© The Risk Averse Alert — Advocating a patient, disciplined approach to stock market investing. Overriding objective is limiting financial risk. Minimizing investment capital loss is a priority.

Analysis centers on the stock market's path of least resistance. Long-term, this drives a simple strategy for safely investing a 401(k) for maximum profit. Intermediate-term, investing with stock index tracking-ETFs (both their long and short varieties) is advanced. Short-term, stock index options occasionally offer extraordinary profit opportunities when the stock market is moving along its projected path.

Nothing is set in stone. Nor is the stock market's path of least resistance always known. More often than not, there are no stock index option positions recommended.


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