Big Action in Triple-Leveraged ETFs

The Direxion Financial Bear 3x ETF (FAZ - commentary - Trade Now) and Direxion Financial Bull 3x ETF (FAS - commentary - Trade Now) were trading fast and furious yet again today, attracting an enormous amount of volume to these triple-down bets. FAZ and FAS provide 3 times minus and plus leverage on the Russell 1000 Financial Index.

FAZ has attracted a significant amount of attention since the National Stock Exchange released the May fund-flow numbers and revealed that FAZ has attracted the second-greatest fund flow of any fund on the market in 2009. Second greatest! The only fund to attract more volume was SPDR Equity Gold (GLD - commentary - Trade Now).

This kind of influx should do more than just raise an eyebrow. Although FAZ pulled in $4.6 billion in assets this year, the fund finished May with $1.6 billion in assets, suggesting that those who jumped in haven't stayed around. Since its November 2008 debut, FAZ has dropped more than 90% from $71.41 in November 2008 to $4.45 at the commencement of trading today. It's not just the bears that are out in droves, however. FAS' volume trails not far behind.

In May, $43 billion worth of FAZ changed hands, but only $1.6 billion was left at the end of the month. What does this mean? The people who are trading FAZ and FAS are likely using it for its intended purpose -- as a trading tool during trading hours. If FAZ is down 90%, FAS should be way up, right? Wrong.

Here's the math problem with leveraged ETFs: Because these funds give you plus and minus exposure on a daily basis, you end up with a little bit of a mathematical problem, since an x% move down will trump the same x% move up. For example, if you start at 100 and have a 10% up day followed by a 10% down day, you end up at 99. By the same token, if again starting at 100 you have a 10% down day followed by a 10% up day, again you end up at 99.

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Don Dion is the publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.

Dion is also president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.