Gilani: Beware of Inverse and Leveraged ETFs, and Stay Away from ETNs

Shah Gilani is a retired hedge fund manager, recognized expert on the credit and financial crises, and Money Morning Contributing Editor.

Gilani points out that inverse ETFs “track their underlying index for only one day at a time”, and do not track intra-day or future moves.

Gilani further points out that inverse ETFs work in counter-intuitive ways. For example, he gives an example where a 2X leveraged reverse ETF goes from 100 to 90 one day, and then back up to 100 the next day.

You would probably assume that – by the end of the second day – your funds would be back where they started. In fact, Gilani explains, you would have lost money.

How?

The drop from 100 to 90 the first day is a 10% drop. But the gain from 90 back to 100 on day 2 is an 11.1% gain, not a 10% gain.

Because of these dynamics, Gilani concludes that inverse and leveraged ETFs “are better suited to day traders than for long term buy and hold investors”.

For a variety of reasons, Gilani doesn’t like ETNs at all.


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  • Math sucks

  • I've read the prospectus for some of these new-fangled ETFs and ETNs.You've got to be nuts or think you're lucky -to see any reason to own this crap.The original purchasers of these shares GAVE their money to the proprietors of these Ponzi schemes, so that the proprietors could play the derivatives markets (within the definition of the prospectus) with the money that was GIVEN to them.If you're buying these shares on the exchanges, you're buying from some financial genius who gambled he could sell his shares to someone like you, for more money than he originally paid for his shares.That's his only possibility.What eluded me completely as I read the prospectus -was, how does anyone value these shares? They have no claim on anything, other than the share.The shares I read about, did not even vote for the board of directors.Read the RJA or the CEF prospectus for an example.As far as I could tell, these shares are nothing more than bags of the sound of breaking wind.

  • Actually, these are excellent trader tools. They are not, however, for investors. Giliani is correct in her assessment and based on that if you could get your hands on actual shares of the paired double or triple etf, e.g. FAZ and FAS and short both you would win as both must eventually equal 1.

  • Anonymous is right. These are great instruments for day traders. These are not long-term investment tools. An experience trader knows it.

  • "[…] if you could get your hands on actual shares of the paired double or triple etf, e.g. FAZ and FAS and short both you would win as both must eventually equal 1."Uh, yeh…. Both of a triple? Sure! I get it.My wife gets all-excited by numbers too. I suspect it is because she doesn't really understand numbers all that well. She thinks numbers are real things that march around the universe holding hands and singing "Pop Goes the Weasel".She is just thrilled when a date like 9-09-09 comes up on the calendar, -as it just did last week.There are no two things in the universe alike enough that we can add them (1+1=2) and think we have said much meaningful about the real state of the complexity of those two, or, any other two things -which are always far too unique to typify, -in reality.My wife doesn't claim any special knowledge for an investment strategy.In my old-fashioned male-and-domineering way, I don't let my wife buy lottery tickets either. Not even on those calendar days when all the numbers seem to line up.I know. I'm just a prick.

  • I don't understand the math here. If you lose 10% on day one and then gain 11.1% on day two, isn't that a good thing? What makes this 1.1% gap? Is this relatively speaking? Is this because of fees?

  • Justin- Just go learn about the miracle of compound interest, and stick with that. That is the best advice you will get. And -if your bank starts hitting you with fees, get another bank.Just think -compound interest-, -compound interest, -and- never lose your respect for the infinite complexity of the Universe.Those two lessons alone will put you miles ahead of 99.9% of everyone else. You'll look like a financial genius, and have money left over from your investment forays too.Trust me. With that bit of financial wizardry, you're even safe handling your parents' money.Leave the "puts" and the and the "calls" to the everyday losers. Their "fortunes" are a dime a dozen.