I’m Melting

Adam Warner, Daily Options Report, looks for evidence that the leveraged ETFs are having an effect on the closing prices of the indices that they trade.

So after all the fuss about Leveraged ETF’s causing their own late day melt downs and melt ups, is there any evidence it actually happens? I mean stocks have closed low and last or high and last forever. Has that pattern of accelerated as leveraged ETF’s gained popularity?

Just to refresh, the concept is that Third parties create these ETF’s for Direxion and ProShares, and those Third parties need to rebalance at some point each day in the direction the ETF is moving. The thought being that this large natural player was piling onto moves already in progress, in addition to hedgies and traders fronting them.

Michael Stokes of MarketSciBlog thinks that there’s not much to see here.

Now I don’t know if traders are seeing a surge in volume near the close (because I don’t trade intraday), I don’t know if leveraged ETFs are responsible for today’s higher levels of market volatility, and I don’t know if leveraged ETFs add potential systemic risk should the market make a really big move up or down (a’la Oct. 1987).

But I do know that, leveraged ETFs are not pushing the market to close at intraday extremes with any more frequency than has been observed historically.

….A simple test. The graph (click thru to see) ….. shows a 1-year rolling average of the % of days that the SPY closed in either the top or bottom 20% of its intraday range (blue, left scale) and/or the top or bottom 10% (red, right scale), from early 1993.

From today, the market has closed in the top/ bottom fifth of its intraday range (blue) 52% of the time, and in the top/bottom tenth 30% of the time, over the last year. And while this is slightly more than the average over the entire test of 49% and 28%, it’s still very much in line with historical norms.

I do believe volume patterns have changed since the popularity of these pups have increased, but that may be sector specific. Financials for example now regularly see the biggest surge in the last few minutes, whereas formerly volume peaked near the open. But it’s interesting that a basic study of price performance shows relatively minor tweaks.

Bottom line I found playing around with this trade is that it only really worked well in the financial sector. That is, if you bought SKF or FAZ in the last hour on an already ugly day, you likely had good flip if you sold it out at the bell. But a combo of everyone in the world gaming this thing, and financials just not moving nearly as much these days, seems to have ended the play