This Day On The Street
Continue to site right-arrow
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

ETFs: The Most Dangerous

Stocks in this article: UNG DTO USO

Editor's note: This is the final installment of our series on the 10 Most Dangerous ETFs. Be sure to read Part 1 and Part 2.

NEW YORK ( TheStreet) -- These ETFs have layers of risk heaped onto already complex strategies. Internal and external forces have made them riskier than they outwardly appear, so it is especially important for investors to understand the multiple reasons why these funds are the most dangerous for buy-and-hold investors.

These funds -- United States Natural Gas (UNG), PowerShares DB Crude Oil Double Short ETN (DTO) and the tandem of Direxion Daily Financial Bull 3X Shares (FAS) and Direxion Daily Financial Bear 3X Shares (FAZ) -- can wreck your portfolio.

Most Dangerous ETFs

3. Direxion Daily Financial Bull 3X Shares (FAS) and Direxion Daily Financial Bear 3X Shares (FAZ).

While sophisticated traders may find these funds effective daily hedges for more complex strategies, they can be devastating to buy-and-hold investors who don't understand their objectives.

Volatile markets can erode leveraged strategies over time, a challenge that FAS and FAZ have recently faced. Here's the math problem with leveraged ETFs: These funds are designed to give you three times the return of their underlying indexes on a daily basis.

Each day, these funds "reset," compounding returns over time. Direxion recently executed a reverse split in both of these funds because their prices fell so dramatically.

2. United States Natural Gas. As the Obama administration makes efforts to coordinate regulatory authorities and crack down on commodity speculators, UNG has found itself in the headlines. UNG's complex underlying strategy has been made riskier by regulatory uncertainty. Here are the top three reasons why investors should avoid UNG.

  • The strategy: In theory, UNG and United States Oil are "purer" plays on oil and natural gas prices than other ETFs like iShares Dow Jones US Oil & Gas Exploration (IEO) and Energy SPDR (XLE) that track equities. While UNG is designed to reflect natural gas prices, it tracks the near-month futures contracts for natural gas, not the spot price. This methodology inherently causes the fund to deviate from its objective, a problem that USO has also encountered.
  • Creation confusion: The price of an ETF should reflect the underlying value, or NAV, of the fund. Unlike closed end funds or mutual funds, ETFs achieve their tracking objectives by the creation and redemption of shares.

    Regulatory limits caused UNG's creation process to grind to a halt back in July. As fund managers waited for the SEC to approve more shares, UNG began trading at a massive premium to its underlying value.

  • UNG's future: After a summer of premiums, the SEC has approved additional UNG shares, and the fund managers will begin issuing new shares on Sept. 28. As UNG is once again allowed to operate as designed, the creation of new shares should cause the fund to once again trade in line with its underlying value. This shift should eliminate the premium and pop the UNG bubble.

1. PowerShares DB Crude Oil Double Short ETN.

  • The strategy: DTO tracks a basket of futures contracts and employs leverage to achieve its strategy. Futures are inherently volatile and leverage adds volatility, so DTO can be one wild ride. Since DTO is structured as an ETN, rather than an ETF, it is also exposed to the credit risk of its issuer. In an era where once-solid banks have crumbled, credit risk is more of a concern than ever before.
  • Bad genetics: When DTO was originally released, it was paired with the PowerShares DB Crude Oil Double Long ETN (DXO). On Sept. 9, DXO was shut down by its managers because the fund's size had triggered regulatory limitations. While DTO has yet to achieve the popularity of its former pair, investors in this fund should be wary of a potential shut-down.
  • Regulatory smackdown: As regulators home in on ETFs like UNG and DTO that use derivative contracts to achieve their objectives, DTO could face double the regulatory restrictions in the months to come. Increased position limits, or restrictions on the number of futures contracts a fund can own, would affect both UNG and DTO and impact their creation process.

The Financial Industry Regulatory Authority has also recently issued warnings about the risks of leveraged funds. Additional margin requirements will be imposed on Dec. 1. Since DTO is both leveraged and futures-based, this fund faces double the regulatory uncertainty in the months ahead.

1 of 2

Select the service that is right for you!

Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!


DOW 18,030.21 +6.04 0.03%
S&P 500 2,081.88 -0.29 -0.01%
NASDAQ 4,773.4720 +8.0480 0.17%

Brokerage Partners

Rates from

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs