Leveraged ETF/ETNs do pose risks most retail investors do not understand. However, retail investors that understand the risks should not be barred from utilizing these very useful assets. Broker-dealers should require due diligence in line with that of margin approval and options approval. Specific arguments for this approach include:
1. An investor can lose 100% of their investment in a leveraged product, but options and margin can lead to more than a 100% loss.
2. Leveraged products can, for short periods of time, substitute for an index position and free up cash while rebalancing a portfolio (i.e., sell $15,000 of an index ETF and buy $5,000 of the 3X ETF to keep a similar market exposure while shifting money from this index to another).
3. Options can offer similar leverage to that of leveraged ETF/ETNs, but can be significantly less efficient (thereby creating greater losses for investors) due to the potential loss of 100% of the options premium when strike prices are not reached.
Another potential consideration is the use of margin along with leveraged assets. While brokers typically will allow only modest margin borrowing against leveraged ETF's, perhaps zero margin on leveraged ETFs would be a better overall guideline. This would help protect not only retail investors, but also market integrity.
Jeffrey Fritts Comment On Regulatory Notice 22-08
Leveraged ETF/ETNs do pose risks most retail investors do not understand. However, retail investors that understand the risks should not be barred from utilizing these very useful assets. Broker-dealers should require due diligence in line with that of margin approval and options approval. Specific arguments for this approach include:
1. An investor can lose 100% of their investment in a leveraged product, but options and margin can lead to more than a 100% loss.
2. Leveraged products can, for short periods of time, substitute for an index position and free up cash while rebalancing a portfolio (i.e., sell $15,000 of an index ETF and buy $5,000 of the 3X ETF to keep a similar market exposure while shifting money from this index to another).
3. Options can offer similar leverage to that of leveraged ETF/ETNs, but can be significantly less efficient (thereby creating greater losses for investors) due to the potential loss of 100% of the options premium when strike prices are not reached.
Another potential consideration is the use of margin along with leveraged assets. While brokers typically will allow only modest margin borrowing against leveraged ETF's, perhaps zero margin on leveraged ETFs would be a better overall guideline. This would help protect not only retail investors, but also market integrity.