With Volatility Rising, Beware The Leveraged ETF

  forbes logoThe following extract from Forbes.com is courtesy of Forbes and their contributing writer Bill Feingold, co-founder of Hillside Advisors. Bill is an alumni of the convertible bond team at GoldmanSachs, Wellesley Investment Advisors and worked for 2 hedge funds specializing in “converts.” He’s also an alum of Wharton (MBA) and Yale (BA), where he also taught “Market Psychology and the Truth about Derivatives.”  MarketsMuse Editor Note: Bill is biased towards the use of convertible bonds vs. use of certain types of exchange-traded-products. Our staff, which is well-versed in convertible bonds, ETPs (as well as underlying products that use futures products) and derivatives found Feingold’s most recent article re: leveraged ETFs a compelling read, hence the ‘share’ with you.

Some who read my posting Wednesday, in which I reiterated my five-year-old argument that convertibles make better long-term investments than leveraged ETF’s, asked me to illustrate how leveraged ETF’s can work against you in ways that may not be immediately obvious.  With market volatility picking up—exactly the kind of environment in which these products do the most damage—I thought it was worth a quick example.

Consider a stock trading at 100. Let’s say you buy an ETF designed to provide twice the daily return, in the same direction as the underlying shares. We will say the ETF is also at 100 when you buy it.