Leveraged ETFs have been the rage, the the talk of the town since late 2007 and early 2008. They seem to be the primarily tool of want to be day traders, and they can work for you too! But they have a darker side, a side that makes me feel bad about putting money in them, a side that may not be safe for anybody.

What am I talking about?

ETFs (Exchange Traded Funds) are financial instruments that were designed by the SEC and various fund managers to provide low cost index following opportunities for investors. This means that management fees are below what a mutual fund would charge with no load and always a present value during market hours (unlike mutual funds that only close you out at the end of the day. ETFs by themselves can provide some layer of diversification in types of investments (but do not guarantee diversification.)

Then, invesco made the short and powershares family of funds that attempt to mimic a short position in the market, or 2x bull or bear the market. Naturally, other fund managers decided to offer similar opportunities and last fall the 3x bull and bear funds by Direxion came out.

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To list a few of these that I’m active in:

• FAS/FAZ 3x Bull/Bear of Russel 2k Financials
• BGU/BGZ 3x Bull/Bear Large Cap Russel 2k
• SSO/SDS 2x Bull/Bear S&P 500
• DOG – Short DOW (GT Student Foundation held this for a while)

The Great

If you want to try market trend trading, what I would venture to suggest as a small form of short term trading very close to day trading, new and old users can get in these funds and track the trends. The market is headed up, great! Headed down, I can follow that too.

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But the Ugly

First of all, these are dangerous because they’re mad volatile. They are even more dangerous to the novice because, they are not priced exactly, and have intraday prices marked the same way a stock does (bid and ask) only to be reconciled at the end of the day. So a 1% market gain could mean a range of 1.8-2.2% action in your ETF.  Then there’s that volatility, you know, that index that rose through the roof as the market hit bottom last November, the 2% swings at the end of the day!

The Thing I Hate though is that these are effectively driving away the actual idea of investment. Options tracking an index have such a little positive effect on an underlying company that we are now just trading financial instruments that have an effect on the market… meaning companies like GM could be going out of business because they don’t need capital because all of our investments are in “financial instruments” of options so disconnected from actual success. A bank could lose all form of market value because nobody is willing to invest in them instead of just trade their options.

I encourage you to look at your portfolio and consider that you put some of it in actual companies and not just financial instruments. Have a positive effect on capitalism, and hopefully through that, the world as leaders are altruistic with their gains. Or, by all means, consider some regular ETFs that invest in actual companies.

Learn more about these

• here http://www.direxionshares.com/
• http://www.invescopowershares.com/

direxion, etf, leverage, Options, sso

More and more brokers are allowing their users to be able to use the trading and risk management strategy of selling “covered calls” otherwise known as buy write style trading. So what is a covered call? Are they too complex? What are the risks?

Calls are a type of option contract (this article is written for American style options) trading the right to buy the underlying security at a given strike price. It’s important to know that options contracts tend to trade in sizes of 100 share increments and that options expire on the 3rd Saturday every month (but some securities don’t “have” them every month if they are low volume.)

Option prices are based primarily on the following:

• Underlying volatility (does the stock move a lot of % every day)
• Price of the underlying
• Distance to strike price
• Time Decay (how long until the expire)

Risks

Covered calls themselves carry an inherent less amount of risk than directly investing in a given security. It is hard to lose money by just selling a covered call (unless the security drops and you don’t buy back your call and sell the stock quickly.) That being said, it is very likely to reduce the earnings that you might have through a security.

Examples

• Buy 100 shares of BAC at $4.64, sell a call at a strike price of $5 for $0.30 a share, so your price per share is now $4.34. In the end, BAC goes to $5.64/share and whoever bought your option exercises it. You make $5-$4.34=$0.66/share, but if you would not have sold the call, you would have eventually made $1 a share.

Trading

In 2008 and 2009 we’ve seen systematic volatility in the stock markets increase drastically — and in an overall negative direction. This provides a huge opportunity for a trade to be established on these calls.

Possible Call Trades on BAC

The idea is just a simple idea of buy low and sell high, but with the call option we are selling at the height, and buying it back at the lows.

I’ve taken the 3 month chart of BAC (it has been extremely volatile over this period) and put some dots at the 20/20 hindsight spots of the trading. You’ll notice that if you had 100 shares of BAC you would have lost a significant amount of value ($10/share),  but thanks to trading covered calls you could have made back up to $6 (very liberal estimate) of that… Not to mention that you’ve kept 100 share of BAC (something that you think is a pretty solid long term 5 year investment.) And that $6 is in 3 months, so in a year, you could potentially erase all losses if you trade optimally.

But It’s Not Easy

So you may be thinking that I just showed you how you would never have to work again in life, but you would be sadly mistaken. First of all, you have to be careful with your brokerage fees: I mentioned that tons of brokers are allowing covered calls; brokers like sharebuilder who charge high commissions. Next we’re talking about a lot of analysis, 20/20 is one thing to say, but when you add that with the emotion of selling close to strike price for more immediate money, you are very likely to not maximize money. To be able to track the stocks you would need to look at them very often and  have some pretty strong technical skills. Finally, there is the possibility in a high news volume market that huge price changes will overshoot your calls, and if you sell a call below your purchase costs, you would be completely out of luck and out of money.

BAC, Bank of America, Covered Calls, Finance, Options, Sharebuilder, Trading