Louis "Zeke" Fritts Comment On Regulatory Notice 22-08
Louis "Zeke" Fritts
Amplified Alpha Capital Management LLC
Leveraged ETF/ETNs pose risks that some retail investors do not understand. As such, broker-dealers should conduct due diligence before allowing customers to purchase Leveraged ETFs. However, such due diligence should be similar to that of mid-level options trading authority. My advisory firm is in the process of launching a hedge fund which utilizes Leveraged ETFs as a part of a risk-managed approach to investing, and through our mathematical study of such products we have quantified the risks of leveraged assets (due to increased price volatility, leveraged asset decay, and in some cases counterparty and other risks). However, we do not support restrictions above what is currently in place or being considered for options or margin approval, as Leveraged ETFs, when used judiciously, are not inherently more risky than options due to the following factors:
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 traditional non-leveraged assets to free up cash for rebalancing purposes, thus avoiding the use of margin to stay "in the market" while rebalancing a portfolio
3. Very modest allocations to leveraged assets, combined with options (such as protective puts) can produce an overall reduction in portfolio total risk, while also enhancing total return
4. 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.
Louis "Zeke" Fritts Comment On Regulatory Notice 22-08
Leveraged ETF/ETNs pose risks that some retail investors do not understand. As such, broker-dealers should conduct due diligence before allowing customers to purchase Leveraged ETFs. However, such due diligence should be similar to that of mid-level options trading authority. My advisory firm is in the process of launching a hedge fund which utilizes Leveraged ETFs as a part of a risk-managed approach to investing, and through our mathematical study of such products we have quantified the risks of leveraged assets (due to increased price volatility, leveraged asset decay, and in some cases counterparty and other risks). However, we do not support restrictions above what is currently in place or being considered for options or margin approval, as Leveraged ETFs, when used judiciously, are not inherently more risky than options due to the following factors:
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 traditional non-leveraged assets to free up cash for rebalancing purposes, thus avoiding the use of margin to stay "in the market" while rebalancing a portfolio
3. Very modest allocations to leveraged assets, combined with options (such as protective puts) can produce an overall reduction in portfolio total risk, while also enhancing total return
4. 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.