A new, exotic ETF product hit the tape this week — single stock ETFs.
The ETFs, managed by AXS Investments, are the first of their kind to be approved by the Securities and Exchange Commission — though similar products have existed for years in Europe.
These new funds allow investors to short stocks like Tesla (TSLA), or make a levered long bet on a name like Nike (NKE) or Pfizer (PFE), with a regular brokerage account.
Another “democratization” of some of the riskier trades available to investment professionals.
SINGLE STOCK ETFs LAUNCH IN THE U.S.
Unlike many ETFs — which for some have become synonymous with index funds like the Vanguard 500 Index Fund (VOO) — these products are clearly intended for active traders and not passive investors. Reason being: leverage is commonly misunderstood and isn’t for the faint of heart.
Leveraged products can cause substantial losses for investors while the underlying stock chops around and appears to “do nothing.”
The goal of a 2x ETF, for instance, is to reflect two times the performance of the underlying stock or index each day. If performance is measured on a longer time period, the results can drastically differ.
Consider the following hypothetical example of a stock and its 3x ETF, which is trying to reflect the daily underlying performance of a given stock times three.
Both securities trading at $100 per share and experience seven volatile sessions where the stock trades up or down at least 10% over the period.
At the end of our hypothetical period, the underlying stock is basically flat while the 3X ETF is down over 40%.
LEVERAGED ETFs PERFORM POORLY WHEN MARKETS ARE CHOPPY
Chopping around with volatility kills these products’ returns, which is the number one lesson investors need to remember.
Let’s look at another example of this dynamic, but one happening in the real world today.
The Nasdaq 100 (^NDX) has been under pressure all year and is currently down about 27%. The ProShares Short QQQ ETF (PSQ) attempts to return the inverse of a long position, while the ProShares UltraPro Short QQQ ETF (SQQQ) aims to return three…
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