If you've ever wanted to short bitcoin (BTC-USD), or use leverage to bet on or against the digital currency, you may soon get your chance. Direxion Asset Management recently applied to create five new bitcoin-related ETFs that could allow investors to do just that. Here are the details, and the dangers of using leveraged and inverse ETFs as investment vehicles.
Direxion wants to create five new bitcoin ETFs
Direxion Asset Management, which is one of the leading issuers of leveraged ETFs, recently applied for approval to create five new funds that track, either directly or with leverage, the daily price movements in leading digital currency bitcoin.
If you aren't familiar with leveraged ETFs, it may be a good idea to read our more thorough introduction, but the basic idea is that these funds seek to amplify the performance of a certain index or asset, generally on a daily basis. For example, a 2x leveraged S&P 500 ETF would rise by 2% for every 1% rise in the underlying index. Inverse ETFs move in the opposite direction of their underlying asset and may or may not use leverage.
Specifically, the five funds Direxion wants to create to allow traders to "bet on bitcoin" are:
- Direxion Daily Bitcoin Bear 1X Shares: This fund would deliver the exact opposite return of bitcoin's daily moves. If bitcoin rose 5%, this fund's shares would drop by roughly 5%.
- Direxion Daily Bitcoin 1.25X Bull Shares: This is a slightly leveraged fund. Effectively, if bitcoin moved 4% in one direction or another, this fund would move 5% in the same direction.
- Direxion Daily Bitcoin 1.5X Bull Shares: A little more leverage than the previous fund. It would move 3% for every 2% move in bitcoin's daily price, and in the same direction.
- Direxion Daily Bitcoin 2X Bull Shares: This fund would double bitcoin's daily performance. If bitcoin dropped by 10%, for example, on a volatile day, this fund would drop by 20%.
- Direxion Daily Bitcoin 2X Bear Shares: This would also double bitcoin's price moves, but in the opposite direction. If bitcoin rose by 10%, this fund would fall by 20%.
Basically, the idea is to give traders a variety of ways to bet on the daily price movements in bitcoin, aside from simply buying the digital currency itself or a fund that invests directly in it.
The dangers of leveraged ETFs
Before you decide to jump in, there are a few things you should know. For starters, leveraged and inverse ETFs tend to have fees on the high end of the spectrum.
More importantly, the fact that these funds track the daily price movements gives them an inherent downside bias over the long term.
Consider this simplified example. Let's say bitcoin drops by 20% on one day and rises by 25% on the next day. If you owned bitcoin, you'd be even after the two-day stretch. If your investment was initially worth $1,000, you would lose $200 on the first day and gain in back on the second.
On the other hand, if you owned the 2X leveraged bitcoin ETF, you would lose 40% on the first day and gain 50% on the second. On an initial $1,000 investment, you would be down to $600 after the first day. A gain of 50% would only bring your investment value back up to $900, leaving you with a $100 loss.
Mixed reactions from Wall Street
To be clear, these funds are in the application stage, and the approval process is likely to take six to nine months, if they get approved at all.
Wall Streeters seem to have mixed opinions on the proposals. Michael Cohn, chief investment strategist at Atlantis Asset Management, said it "would be insane for them to actually approve this." Cohn went on to say that he would never put one of his clients in a product like these.
On the other hand, some people are excited at the prospect of leveraged bitcoin ETFs, calling it "eye-watering." Nick Colas, founder of DataTrek Research, is one of them: "Can you imagine what a 2X bitcoin put or call is going to do? It's going to be amazing volatility."
The bottom line
Leveraged ETFs definitely serve a purpose in the market, but for the most part, they're best left to professional traders. If you have a strong opinion on bitcoin one way or the other, it may seem like a good idea to use a product like those Direxion is proposing. However, it's important that you have a thorough understanding of how these products work and the risks involved before you consider them for your investment strategy.
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