Leveraged ETFs

When you think you are going to be right about where the market is headed, it is a natural desire to seek creative ways to maximize your profit. That's why ETFs that are leveraged to double the return of the market are increasing in both interest and popularity. In fact, it is rare that I don't receive an email every day that someone doesn't ask for my view on one of the ProShares' leveraged ETFs.

Like a lot of ETF providers, ProShares hasn't stopped there. We now have leveraged ETFs for individual sectors for those of you who think specific sectors are going to outperform/underperform.

So, what are my thoughts about these offerings? The bottom line is that I think they can be good trading vehicles, but with three main caveats:

1) Liquidity: the liquidity in many of these products still isn't at the same level as the more mainstream ETFs like the QQQQ, DIA, and SPY. This is important to those of us who trade in relatively large positions and who are reasonably concerned about the reliability of current electronic trading systems in a major market correction.

2) Expenses: the expense ratio is higher in this products making them far less friendly for long-term investors and, if used incorrectly, will tend to increase trading costs, taxes, and trading activity which is not ideal for most investors.

3) Suitability: these kind of ETFs are only suitable for a small part of the population. In sum, if you can't already time the market consistently well using the non-leveraged market-matching ETFs, then using leverage is only going to maximize both your profits and, more importantly, your mistakes. While the market hasn't been volatile of late, many people, including myself, think that will change. If so, can you handle 2% to 5% daily swings in these kind of positions? If you've never tested your resolve, emotion, and strategies in that kind of pressure-packed situation, you're far better off to learn how to walk before you run or you will get yourself in serious trouble very quickly. I would only recommend these to advanced traders who are looking to increase some beta in their portfolios (as a relatively small percentage of net assets) AND who already have shown they can handle the increased risk and pressure these kinds of ETFs bring to the table.

The speed and frequency of new ETFs being released these days will literally make your head spin and, like many of you, I also have trouble keeping up with all of the new offerings and latest trends. If you have tools and websites you find particularly helpful to stay on top of these, please let me know. Like before, I'll be sure to pass your recommendations along in a future post.