Leveraged exchange traded funds (ETFs) have been enjoying the limelight on Wall Street, but there are concerns over the the volatility that are incurred in the last moments up till the closing bell. Are these concerns founded?
New research shows that leveraged ETFs could trigger a buying or selling bonanza in the moments leading up to the market close when the a market makes large moves, reports Jason Zweig for The Wall Street Journal. At the end of the day, these ETFs will adjust their exposure by “releveraging” their positions.
ETFs that are leveraged generate a multiple of their benchmarks. They need to adhere to a “total-return swap” that requires a fund to maintain 100% or 200%, depending on the leveraged multiple, in swap exposure. Inverse funds must also buy or sell to keep its leverage ratio constant. These ETFs would then either create a buying or selling frenzy to keep their ratios at the end of the day.
Some have estimated that in a worst-case scenario if an index moves 15% then leveraged ETFs could make up 75% of the volume at closing trades. That’s not true.
The truth is that these types of ETFs do what they’re supposed to, and there’s just no evidence that they’re hurting the market, nor are they going to cause a market implosion. We’re coming off a hugely volatile year, and these ETFs operated in lockstep and did what they should. We watch these ETFs closely and there’s no reason investors should stay away, provided they know what they’re doing.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.