The danger of leveraged ETFs

These exchange-traded funds, created to give individual investors the same leveraging opportunities that hedge funds have, don't level the playing field -- they distort it.

By Jim Cramer Sep 16, 2011 9:17AM

the streetWait one minute. A rogue trader at UBS lost $2 billion trading ETFs versus underlying stocks with derivatives? That's what the unauthorized trades were about?




Typical of what we don't know about these instruments. Typical of the confidence that securities people place in the way ETFs work versus the actual securities they are supposed to represent.


If a major company like UBS, with all sorts of risk controls, couldn't see through what a trader might have been doing as he flitted back and forth through the ETFs to the underlying stocks to the options market, are we really supposed to be able to trust these kinds of desks when they tell us not to worry, that ETFs aren't more powerful than the stocks?


Should we really trust them when they make their assurances that ETFs, particularly the double and triple ETFs, don't affect the markets in bizarre and difficult-to-understand ways, including exacerbating trends that shouldn't be exacerbated?


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We've created a ton of financial instruments of late that are allegedly supposed to give individual investors a chance to trade anything with the same leverage that hedge funds have. This is the super-democracy movement of allowing the little guy to make intraday bets against or with indexes using tremendous leverage, bets that pretty much need to be taken off each day because they don't really work as long-term hedges.


No matter that most of the people who use these and call into my show have no idea that they don't work as long-term hedges. No matter that they are too big and powerful against the whole market, not just their sectors. The creators have sold the SEC on the idea that these are terrific, ingenious instruments.


To me, the fact that someone could hide $2 billion in losses on the Delta One desks shows that not only do the promoters of this nonsense make claims of innocence about their impact -- they don't even know how they work.


There are many reasons individuals hate this market, but one of the major ones is that the products they have been sold, mainly these ETFs, are just ways of betting on teams that have nothing to do with investing. These ETFs don't level the playing field, they distort the playing field. As you can tell from the spate of articles about this rogue trader, there are big desks that, every day, ensure that every nook and cranny gets exploited, to the detriment of the overall market and even to the detriment, we now learn, of themselves.


They are here to stay. They are parasites on the system. They are blessed.


They are another reason to hate the market. But let's use UBS as Exhibit A in the case against the promoters of these instruments who say "Don't worry about them."

Even they, the big exploiters, have no idea how they work, or you couldn't hide the loss. It would be one thing if the promoters just came out and said, "We are issuing these securities so big trading desks can make lots of money," instead of saying they offer the variety of choices that the little guy wants.


But, no, they cloak themselves in goodness.


Someone, someone please tell me why we have to have these, other than for desks to make minute amounts of money at the expense of the market.


Maybe the rogue UBS loss will shed more light on what the heck we are doing with these products. And make the defense of them more naked, as we now know that the Delta One desks rule -- and rule, in this case, with abstruse abandon.

Image: Jim Cramer

Jim Cramer is a co-founder of TheStreet and contributes daily market commentary to the financial news network's sites. Follow his trades for his charitable trust.

Sep 16, 2011 11:59AM
In this case I think that Cramer is right on the money.  Derivative use has exploded in the markets after the Commodity Futures Modernization Act of 2000 was slipped into an appropriations bill (you can thank Phil Gramm, a major sponsor) and removed what was by then the $94 trillion OTC-derivative market from all federal regulation. During the subprime crises this market had grown to $600 trillion or 10 times the world’s gross domestic product. Approximately one-tenth of the unregulated OTC market was made up of the now-infamous credit-default swaps (CDS), a product that Wall Street sold to “insure” sub-prime mortgage investments but which lacked regulation and, therefore, the capital required to support these “guarantees", (actually bets on the market).   While the default of these loans may have been the spark, the massive amount of money in naked and synthetic CDS's and the lack of capital to back these bets was the reason that the housing market almost took down the finance industry.  In the end, we the taxpayers had to bail out these companies only to be slapped in the face when they turned around and gave out huge bonuses that year.
Sep 16, 2011 11:20AM

let's not forget that if these etf's are so bad we could just short them and make a killing


the truth is they are convient short term instruments for shorting the market




Sep 16, 2011 11:55AM
Never forget that Cramer's first instinct is to protect the big moneyed interests of the east coast.
Sep 16, 2011 9:49AM

These leveraged ETFs are dangerous, and the many pundits that keep recommending them are doing a real disservice to small investors... they seem to be a way to separate investors from their money.  Granted, if you bet correctly, you can make a big gain, but the timing is everything and you have to jump in and out.  Every time I've tried to use them, I end up losing money.  Granted, I'm not a skilled investor... but I'm convinced these things are crap.


Sep 16, 2011 11:55AM
There you go again, you are such a flake, someone should plug that pie hole of yours.
Sep 16, 2011 12:51PM

Remember Shultz on Hogen's Hero' s  ,  well I don't know nothing but my bottom line , and fact of it is UCO , and SDS have me up, 60% for the year.   I am out of both , but there is always a time , when the bad and the ugly, can be good   . We all know Jimmy need to be heard  , and he may have a few issues  but to be a fool 3/4 of the time and keep at it , say's something ,  its all about knew business , and banging at that door. let it be good bad or ugly    ,  there is a handle in your hand, knowing if its good or not, means nothing ,it is what there thinking across the room that gives  value  and timing is your only friend,   babble babble

hasta nunca  people.,.,

Sep 16, 2011 12:50PM
If you are losing money with ETF's it's because you are buying the wrong ETF at the wrong time. The losers at online poker say the same thing, "its rigged". But their money ends up in my mailbox because they don't know how to play and won't commit to learn how. It is a game of skill. Learn WTF you are doing.
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