Taking On Volatility With Geared ETFs

Inflation. Fed Hikes. The Ukraine-Russia crisis. The midterms.

These factors pushed the major equity indexes toward their worst returns since the beginning of the pandemic. But traders put nearly $6 billion in new assets to work in leveraged and inverse ETFs during the month, making them the fastest-growing segments of the industry by percentage.

Dave Mazza, managing director and head of product at geared ETF issuer Direxion, spoke with ETF.com about what his firm is seeing from traders setting single-day hedges and bull bets.

ETF.com: This is a particularly volatile time in the market, and this January was the worst month for returns since March 2020. We have inflation, the potential for the Fed to hike aggressively, COVID is still a problem and there’s a brewing crisis between Russia, Ukraine and the rest of Europe. With all this volatility, how do you think traders using leveraged and inverse ETFs are deciding which topic to focus on?

Mazza: One of the things we're seeing with the trading community in how they're engaging with our leveraged and inverse suite at Direxion is that the amount of uncertainty that’s increased and weighed on market sentiment broadly has not necessarily impacted them.

I point to the considerable inflows into two areas. One is our bullish semiconductors ETF [the Direxion Daily Semiconductor Bull 3X Shares (SOXL)] and the other our bullish biotech ETF [the Direxion Daily S&P Biotech Bull 3X Shares (LABU)]. We know semiconductors have been an area that had excellent performance as growth and momentum names were in favor for the better part of 2020 into 2021, until, of course, the wobble. Biotech has been an area that was beaten down.

What this tells me is that the trading community is not going down [without] a fight in either a broad-based rotation away from growth into value or a broader retrenchment from the equity market into safer assets.

I find this confluence to be quite unique, because performance in January was particularly difficult across many markets.

ETF.com: So there is an embrace of volatility happening with the traders then.

Mazza: Traders are not hunkering down. Now, certainly, sentiment could change if January's performance moves into February and February moves into March and we see a really broad-based pullback. But really since the COVID crash in 2020, we've seen the leveraged and inverse products, particularly those on the bull side, embraced by traders. Assets have increased, volume has increased.

This recent bout of volatility … has not seen them become more bearish. I think there's still an embrace of risk and a belief that this pullback continues to provide opportunity on the upside, at least from what we're seeing with flows and activity.

ETF.com: The ProShares UltraPro QQQ (TQQQ) through January gained $3.5 billion in new assets, while the Invesco QQQ Trust (QQQ) went into a correction. It seems counterintuitive to be making a triple bull bet for tech at a time when it seems like so much of the technology industry has head winds against it.

Mazza: We are definitely seeing what I'll call countercyclical activity among traders. That said, we did see some pretty significant activity in inflows in the last few weeks into our inverse S&P 500 product, the Direxion Daily S&P 500 Bear 1X Shares (SPDN). It’s not leveraged two or three times on the bear side, so it's really used more as a direct hedge against the S&P 500.

Even as some traders have been continuing to plow into the tech and in the growth space, we did see (SPDN’s) highest-ever trading volume and its largest-ever inflows in the last few weeks.

SPDN Flows Since Inception

Data courtesy FactSet

There’s certainly a camp that’s looking to hedge portfolios, but it's not dominant in any way, shape or form at this point.

ETF.com: I'm wondering if you're seeing a difference in strategy for a trader who may be looking to use a geared ETF to play a specific economic event, such as the Fed raising interest rates or inflation going up versus political and geopolitical issues, like the midterm election in November or the ongoing crisis in Europe.

Mazza: I think the idea that the situation in Ukraine, between the U.S. and Russia, or even, taking it a step further, thinking about potential for China and Taiwan, has not really weighed on trader sentiment yet. The majority of the moves we’ve seen all goes back to the path and pace of interest rate hikes and what volatility the Fed may bring to markets more broadly.

Barring a really difficult crisis, I still think the Fed and everything that comes with it will be the main driver of sentiment on a daily basis until we get to the meeting in March.

Contact Dan Mika at [email protected], and follow him on Twitter