Bank stocks on steroids
If you're an active trader with a stomach for risk, some new ETFs that focus on banks could be for you. Just make sure you don't hold them for more than a day.
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| Two bank ETFs that use leverage to magnify daily returns could work great if you actively trade them. But they are terrible ways for long-term investors to make bets on bank stocks because of their volatility. |
NEW YORK (CNNMoney.com) -- If you look at the most actively traded stocks on any given day, there usually are no major surprises. The biggest, most widely held companies in the news tend to have the biggest trading volume.
So on Friday morning, for example, it made sense that big banks like Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500), everybody's favorite insurer AIG (AIG, Fortune 500) and General Electric (GE, Fortune 500) all topped the most actives list.
But often, exchange-traded funds, or ETFs, have heavy volume as well. And two that allow people to make bets on bank stocks have become particularly popular: the Direxion Financial Bull 3X Shares and Direxion Financial Bear 3X Shares.
More than 323 million shares of the Financial Bull ETF (FAS) traded hands on Thursday while nearly 87 million shares of the Financial Bear ETF (FAZ) were traded. To put that into perspective, GE's trading volume Thursday was about 160 million shares.
So what the heck are these two ETFs and why are they so popular? And should you consider investing in them?
Before I answer that, here's a quick explainer on what an ETF is in case it's not something you're familiar with.
ETFs tend to own baskets of stocks tied to particular market indexes, similar to a mutual fund you might own in your 401(k). ETFs have become increasingly popular during the past few years because they trade like stocks and are usually easier to buy and sell than a mutual fund. Plus, they tend to also have lower fees.
The Direxion Financial ETFs track the Russell 1000 Financial Services Index, which includes most big banks and insurers. So when that index goes up, so does the Bull ETF. And vice versa for the Bear ETF.
But here's where things get a little more complicated. Remember that the full name of these ETFs are the Financial Bull 3X and Financial Bear 3X.
What that means is that each ETF isn't designed to merely mirror the performance of the index, but outperform it by a factor of 3. The funds do this by investing in companies in the index as well as using swaps and derivatives contracts that add leverage to the bet to juice daily returns.
As of early Friday morning, the Russell 1000 Financial Services Index was down about a half of a percent. True to its name, the Financial Bull ETF was down about 1.5%. Similarly, the Bear version was up about 1.5%.
So with all that in mind, the answer to my question about whether you should invest in them seems like a no-brainer right? If you think bank stocks will continue rallying, buy the Bull ETF. If you believe banks are doomed, make a big bet on the Bear ETF.
But here is where things get tricky. Because of the high amount of risk and volatility in the market, these ETFs are not for the faint of heart.
Even the chief investment officer of Direxion says that the longest you probably should hold on to either of these ETFs is for a day.
Consider this. The Bull ETF has, not surprisingly, plunged more than 50% since it started trading in early November. But even though bank stocks have plunged in the past few months, the Bear ETF is actually down more than 50% as well.
Why has the Bear ETF done so poorly? It's because the addition of the leverage makes the daily returns extremely volatile. So even though you could have a couple of days in a row where the ETF is up, all it could take is one big day to more than wipe out the prior gains.
"It's a function of compounding. The bear fund, for example, could be up strongly for weeks at the time but when markets rally, as they have lately, it goes down sharply," explains Daniel O'Neill, president and chief investment officer of Direxion.
For that reason, he said these ETFs really should be used by professional traders only, not the average investor looking to buy and hold.
"If you are thinking of these funds but are not going to look at them for a month, then don't buy them," O'Neill said. "These are marketed to and created for people that are really actively trading their portfolios. The average turnover for all the shares in the funds is half a day."
This helps to explain why the volume for these two ETFs is so high. Still, an ETF expert at Morningstar is worried that some individual investors may be buying them as well.
"I am concerned there are investors who don't understand the products, There may be a contingent of the market that views the Bear ETF as a way to profit by shorting bank stocks," said Paul Justice, ETF strategist with Morningstar.
"That can work for one day. But daily's not monthly and definitely not annually. If you buy and hold these ETFs for a long time, the returns will look more like random numbers being generated," Justice added
O'Neill said, however, that he does not believe many smaller individual investors are buying these ETFs. He said most of the company's clients tend to be hedge funds, investment banks and high-net worth individuals looking to balance out other bets or make fast profits.
So consider yourself warned. These ETFs could make you a lot of money if you are willing to watch them like a hawk. But you could lose your shirt if you don't monitor them closely.
"You have to stay on top of it on a day to day basis," Justice said, "If banks stocks do go down over 15% during a certain period, you could still lose a lot of money on this type of bearish ETF because the return is dependent on the path, not just direction. You need to know how many down days versus up days there will be and when."
Shameless plug alert: Before I started writing The Buzz, I covered the media business for several years at CNNMoney.com. Some of this reporting is the basis of a book I've written about News Corp. CEO Rupert Murdoch called Inside Rupert's Brain, which was published on March 19 by Portfolio, an imprint of Penguin Group (USA). 
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