When trading or investing it helps if we know what we’re doing. That means grasping that certain instruments are designed for specific purposes and not just don’t work well, are positively money losing, when used for some other purpose. So, it is with the Direxion Daily Semiconductor Bull 3x ETF (NYSEARCA: SOXL). This is for trading, not investing.
There’s an old joke, Bert says to Phil “Those herrings you sold me, the wife and I had some, they were terrible” and Phil says “Bert, those herrings were for selling, not for eating”. The Semiconductor Bull 3x ETF is for trading, not investing. It’s an important distinction.
This particular ETF, SOXL, usually ranks in the top half dozen by volume traded, and is near always the top leveraged Exchange Traded Fund (ETF). It’s exactly that leverage, the 3x, that makes it a trading, not investing, item.
The ETF tracks the index
The specific underlying that is being tracked is the ICE Semiconductor one. Without getting too deeply into the details it’s tracking the large cap companies in the semiconductor business. So, if we want to invest in or trade upon the relative or absolute performance of that industry then that’s where we can do so. Whether we wish to do so is up to us of course.
An ETF makes trading such an index as easy as share or stock purchases. So, an ETF is a fine way of trading that index if we wish. It’s when we start to add leverage that we need to start making distinctions. There are 2x ETFs, both bull and bear, 3x as here, from a number of different providers. The 2 and the 3 refer to the leverage – they are set up to provide two times, or three times, the daily movement of the underlying index. And it is this that marks them out as trading instruments not investing ones.
How an ETF gains leverage
For the way that the Semiconductor 3x ETF gains that 3x leverage is through a mixture of futures and options on the index and the underlying index components. Futures and options have a time value which declines. So, over time – weeks and months – a leveraged ETF will lose substantial amounts simply because of the method of construction. There are also other value destroyers as the SEC lays out here.
A buy and hold strategy for the Direxion 3x Bull Semiconductor ETF is not a guaranteed money loser, that depends upon the performance of the underlying ICE Semiconductor Index – a strong rise in that will cover most sins. So too the Bear 3x equivalent. But a buy and hold in a leveraged ETF will be a money loser compared to other ways of constructing the same position.
We don’t have to use an ETF to gain leverage
This is an important concept to grasp. We can recreate the same economic positions – being leveraged long on semiconductors in the example here – in a number of different ways. Which is the best method depends on exactly what we’re trying to do.
A leveraged ETF, like NYSEARCA SOXL, is constructed to be useful for intraday movements. That is, buy now, sell in a few hours. It has very high liquidity, therefore a low spread and dealing costs. But those advantages are bought at the expense of a known and substantial built in day to day and week over week loss.
We can though, as we say, recreate that position another way. Clearly, we can trade the index itself but that might not attract. Or we could trade a non-leveraged ETF – these exist in profusion – but what if we still desire the leverage? The answer there is to trade the unleveraged ETF but gain the leverage through the broker. This would be that same economic position we’ve just avoided the built in losses from the construction of the leveraged ETF.
Which instrument we use for what is important.
All of this is not to say that we should be trading the semiconductor index, nor that we should be bull or bear, leveraged or not. It is to say that if this is what we desire to do then we need to be selective over the instrument we use to do it. If we’re after a leveraged bull and short term – intraday – play on the sector then yes, the Direxion Daily Semiconductor Bull 3x is a perfectly useful instrument to use. Quite possibly the best out there in fact given the liquidity. But if our desire is to have a long term – anything more than a few days in fact – bull position on that same semiconductor index then a better construction of economically the same trade is a non-leveraged ETF juiced up by leverage from our broker.
Which instrument we use to do what, really does matter!
