Friday, April 24, 2009

Leveraged ETFs: Making Volatility More Volatile?


Here we see the five-minute ES futures for Friday, plotted with a 20-period volume-weighted moving average. Note how volume and volatility picked up dramatically around the 13:00 PM hour, with the announcement of bank stress test details. Twice in the day, we saw buying interest peter out at new highs for the day, followed by violent selling and equally herdlike buying. This created volatile oscillation around the VWAP, trapping buyers and sellers alike.

We've been seeing an increasing amount of this herdlike intraday behavior, especially in afternoon stock market trading. This is playing havoc on short-term traders and also longer-term swing traders, who find good positions quickly going bad. There is speculation that leveraged ETFs are contributing to these bandwagon effects, which could ultimately generate 1987-style portfolio insurance-style risks for the market.

Here is the original article that outlines how frequent portfolio rebalancing among leveraged ETFs "magnifies intraday movement". What this suggests is that volatility itself is becoming more volatile as an increasing number of leveraged ETF participants join the market. Today's trade may just be a harbinger of things to come--and adjustments traders need to make.
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4 comments:

Matthew C. said...

I was thinking about this today when the ES began to collapse after 3. I figured it was the ultra ETFs running out of their positions. I'm done with dealing their that kind of yoyo movement.

This is why I don't do much trading after 3 anymore.

Rick said...

I've seen several people speculate that leveraged ETFs are the cause for the late-day violent moves we've been seeing, but that explanation does seem a bit facile to me. They make a convenient scapegoat, and at first blush the explanation fits well-enough.

The timing of the wild rides varies (3:30pm Weds, 2:50pm Thurs, 3:50pm today). But some days it isn't there at all. Monday was a huge down day, where were the leveraged ETFs then?

Has the end-of-day wild ride correlated with increasing volume in the 3x ETFs since they were introduced? That would be an interesting thing to check.

If someone has explained this, would be great to have a link. Or if someone with inside knowledge could verify or debunk this theory, that'd be great. I'm skeptical that it's that easily explained, I suspect some black boxes are piling on too, completely without factual support of course.

abel said...

at the rate its going..double / triple etf's, pretty soon it'll be the equivalent of trading futures-like instruments, in a non-futures trading instruments.

fiki said...

Dr Steenbarger
Zero Hege (one of the top 5 blogs i daily cover - yours included:) ) has a theroy that a lot of market "crazyness" is because of ongoing quant dislocation effekting the market liqudity very bad. Just today he posted that the biggest quant of all Renaissance Underperformed S&P by 17% in april. He´s also "tracking" these program trades and NYSE shows they are now 30% of the market volume and that the biggest player Goldman Sachs last week made 1 billion shares principal transactions, x6 its costumer and agency trades. This would explain the "crazy" tick readings these last couple of weeks.
Anyway I would really appreciate your view on matter, maybe in a future blog post.
Thanx, a very satisfied follower.
Filip