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Friday, December 12, 2008

Investing in FAZ (Financial Bear 3x) and FAS (Financial Bull 3x)

As I became more interested in investing in FAZ and FAS, I first looked at all the posts in the forums and tried to filter out all the "trolling" and it seems to me that many don't understand what they are investing in.

This blog takes attempts to take out all the noise and attempts to look at the numbers objectively, to try and develop an investment strategy in FAZ or FAS. I'm doing this research myself, so thought I'd share it and post it in other forums to help people figure out the maze.

First the introduction, FAZ and FAS are 3X leveraged ETF's that track the Russell 1000 Financial Services (RGS) Index.

The first thing to note about these ETF's is the leverage. The leverage for these funds is at 3x. There are other ETF's tracking indexes leveraged 2x and other's that are not leveraged at all. The key here is to understand what "leverage" exactly means? Does it mean that for every 1% change in the index, leads to a 3% change in the price of funds? I wasn't too sure and plenty of the forums in these funds elude to buyer beware messages. So let's crunch the numbers and see exactly what it means. (Click the graph)

The first thing to note is that the ETF's inception date was November 7 and if we had bought both funds and held onto it til the present date, we would of lost a great deal on both sides of the coin. As of December 12:
  • RIFIN.X (-14.5%)
  • FAZ (-39.7%)
  • FAS (-53.81%)
By looking at the names of Finanacial Bull 3x and Financial Bear 3x alone, you might expect the following performance of funds in the funds with the RIFIN.x losing 14.5% since inception:
  • RIFIN.X (-14.5%)
  • FAZ (33.5%)
  • FAS (-33.5%)
However, that is not the math that these funds are following and it is actually contained within their prospectus. If you have not viewed the prospectus, I highly recommend that you do.

So let's look at the following hypothetical scenario to try and explain what it means to be 3x leveraged and try to explain the above scenario.

So as we see, ultimately, that over time, this fund will lose you money. It gets increasingly more difficult for these funds to get back even, even more so as the RIFIN.X fluctuates up and down. People holding this fund for over 3 days need to keep reading.

Holders beware, do not hold this for over a day in your portfolio for the reasons stated above. This ETF is for day traders only, who can take advantage of a volatile swing in the index in less than 24 hours. There is no reason to hold FAZ or FAS, because ultimately you are betting on multiple day bear or bull rallies. It's a slippery slope, but most of it is downhill if you hold.

On the google forums, posted a spreadsheet with FAS and FAZ prices along side the RIFIN.X prices, to illustrate how FAZ and FAS are priced.

If you have any questions about this, just fill out a comment below and I'll get back to you.


  1. How come all three are assumed to be $100 on day 1. Shdn't it be a bull/bear factor of 3 times the RIFIN to begin with. I am just a newbie struggling to understand how this works.

  2. I only choose $100 on day 1 for the value of each funds, to help illustrate the leverage (3x) of the fund on the RIFIN.X index. It's a totally hypothetical illustration.

    The leverage is based on percent gain rather than value. Because of this leveraging, you'll see that overtime, even though RIFIN.X got back even, the funds both would report a loss.

    In the end, this is something you play on a volatile swing in the span of one to three days. Do not hold this fund. Hope that clears things up and thanks for reading.

  3. For a while now I have been considering a strategy of shorting the triple ETF's particularly the FAZ to take advantage of this "decay" phenomenon instead of going long the opposing index. Obviously a person would want to find a good entry point when the ETF is high because a quick double in the price could cause an equally as quick margin call. Ideas???

    Personally, I feel doing this with option derivatives would actually be less risky and more profitable when done right because the loss potential is limited whereas that is not the case when shorting an asset.

  4. It's a very interesting idea and probably the best idea I have heard so far to mitigate risk. You've got me interested in the long straddle and I may do some more research on it.

    I'll try to get back to you via another post on this blog.

  5. This comment has been removed by the author.

  6. The initial price for RIFIN $100 is an assumption thats ok.
    But what shud be the initial price of FAS and FAZ.
    You are assuming they will be $100.

    Actually what were the initally prices of FAS and FAZ?

  7. Over time FAS/FAZ tend to lose money. These ETFs are good only for daytrading and very short-term plays. If you put them on the same graph, they're not a mirror reflection of each other.

  8. So wait, won't these both eventually go to $0 (or thereabouts)? What happens then?

  9. I held fas for 5 days w/margin and made a load of cash yesterday

    Don't day trade these stocks, you will lose your ass, fast

    They both closed down today

  10. Daytrade or not, is not the point to avoid a sideways movement for to long?

  11. Overtime these funds will decay, but will never reach 0.

    As for holding fas, yes you caught it on the upswing when the RIFIN.X went from 600 to 660. You were on the right side of things when the index posted multiple day gains. However, if the index saw sideways movement during five days, you would have been down because of decay, which is the point I'm trying to make in this blog.

  12. hi there--well I got caught on faz at 57--any way to average with options? I thought of averaging in --big time down any advice?

  13. You got caught in the leverage trap. There's a link to the prospectus in the blog, which should help you learn about the leverage trap.

    You would have to go back to early December to see FAZ at 57. My only advice is to not hold faz (or fas for that matter) for more than 3 trading days. Averaging in may mitigate your losses, but will not mitigate your risk. Your play becomes riskier with each passing day.

  14. Won't the exact same thing happen to any stock, in a bear market, just at a slower rate? Even XLF will decay overtime. Any stock would theoretically decay over time.

  15. In a bear market, the valuations of stocks lower, but not due to decay or the leverage trap phenomenon described above. XLF is a non-leveraged ETF. It follows the percentage fluctuations on a 1-1 scale of the Russell's Financial Index (RIFIN.X) and will experience no decay.

  16. I am a newbie trader. Bought FAZ and held last Th and Fri while the market fell. It covered the losses on 2 long positions I own. Took my profits Fri PM.

    Glad I did, because in pre-market trading yesterday, 3/23/09, folks had already erased all of my gains and then some.

    In pre-market, they had already run up FAS by $1 (20%). I got 700 shares of FAS at $6.2 and made $.87/share which is a nice gain but the pre-market trading swallowed up the 1st $1. Had I been more alert I could have had an extra $700. Lesson learned.

    I am holding FAS today as it trades sideways. May sell today, may go one more day.

  17. I see the point you are making here. If this is true, people can make a lot of money from short selling these stocks or buy (3-5 months) put options on these two.

    I just bought the FAS and I think I will hold them no more than 3 days.

    The spreadsheet is very nice. Thanks.

  18. you will LOSE a lot if you short both ... the assumption is that this index will go back to the original point and you can make money ONLY if it fluctuates hugely(writer gives 10%) for the first two days, if the index rise for 2 consecutive days, or it declines for 2 consecutive days, or it fluctuates for 2 days with a normal rate(less than 10%), you LOSE

  19. In the prospectus it says the ETFs track "DAILY performance" and is only for "sophisticated investors who understand the risk" i.e. not INVESTORS at all but traders, holding for a couple days or even less.

    Quit poo-pooing all over the ETFs. If you found an index that moved so wildly, the same effect would happen due to compounding.

  20. I covered this in a personal blog, but shorting both FAS and FAZ is akin to entering a short straddle on the financials. You profit from flunctuations if the expected mean return is zero. However, with any directional move, you will lose a huge amount of money (read up on Nick Leeson and Barings Bank).

  21. Thanks for the insight Jim. I agree. You are absolutely correct. If you short both FAS and FAZ, you are essentially entering a non-directional position on financials.

    Any straddle play is a play on volatility. A short straddle is a non-directional play betting on low volatility. Considering that this is a leveraged fund, you potentially can lose a lot of money with these high volatile swings.

    However, a long straddle involves purchasing a call option and a put option on the same index. The two options should be bought at the same strike price and expire at the same time. You can make a profit if the underlying price moves a long way from the strike price, either above or below. Thus you may take a long straddle position if you think the market is highly volatile, but do not know in which direction it is going to move. This position is a limited risk play. The most an investor can lose is the cost of both options. At the same time, there is unlimited profit potential.

    You may want to look into that as well my friend.

  22. Thanks for the info. Very useful.
    Thus, these stocks will eventually decay to a very low price. What happens then? Are they removed from the market?
    When these stocks will definitively lose value, why are there call-options, some having an expiration date of 2011?
    Are put-options a sure winner?

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