Confessions of a Leveraged ETF Junkie, Part 1

We are all junkies, whether we admit it or not. Each one of us can pinpoint a moment when our interest in the markets turned to addiction. Mine was when I spurned a broker's advice while involved with a stock market game back in high school. Instead of buying his recommendation (Pepsi (PEP - commentary - Trade Now)), I took our last-place portfolio and went all in on Scoreboard for the nine weeks that remained in the competition. One free trip to the NYSE floor later (after a monstrous climb in the standings from 273rd to 5th), I knew I was hooked.

Make no mistake, we are all addicts. You will seldom hear about accounts that were bankrupted, the trades that went against us, or the decisions that were made out of "tilt" as opposed to sound reasoning. And the rare times that you do hear these stories, they generally come from someone who is now wildly successful and wealthy. This is what makes us human, but it also means that we can continue to learn and grow.

The most dangerous thing about the capital markets is that they are like dealers ever feeding our addiction. Wall Street pumps out new products that grow, morph and change right along with our addictions. One of these new addictive products for many traders is also one of the most hotly debated: leveraged ETFs.

I have followed leveraged ETFs since day one. The concept is not new. In fact, several of the current leveraged ETF providers ran the concept via mutual funds for the last five to 15 years. I utilized these funds when developing portable alpha portfolio models until the dramatic impact that volatility could have upon returns became evident. I observed the oft-mentioned volatility decay firsthand, the negative drag/impact of volatility in connection with the daily rebalancing of leveraged funds.

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At the time of publication, Collins was long FAS puts, short FAZ calls. No other current positions, but the author will often hold positions in the following leveraged ETFs: TNA, TZA, DIG, DUG, ERX, ERY, SSO, SDS, BGU, BGZ, UPRO, QLD, QID, TYH, TYP, TBT, EDC, EDZ, EEV, SRS, UYG and SKF.

Timothy Collins has worked as a financial adviser since 1999, focusing on portfolio customization with a concentration on income and risk-managed growth. He started Collins Capital Advisors -- now Clarus Capital Partners -- in 2007; Clarus Capital is an RIA firm dedicated to formulating customized risk-managed investment strategies for individuals and small businesses. Clarus Capital now manages the Triplicity Capital Fund, a volatility arbitrage hedge fund.

Prior to joining his first firm, American Express Financial Advisors, in 1999, Collins worked as a staff accountant for United Information Systems in Bethesda, Md.; he has also worked as a financial analyst for Securities Pricing and Research in Annapolis, Md. Collins is a graduate of McDaniel College (formerly Western Maryland College) with degrees in business administration, economics and sociology and is a winner of the Bates Prize.