How Investors Are Using Single-Stock ETFs

Direxion knows leveraged and inverse ETFs. It manages some of the most popular funds in the space, including the Direxion Daily TSLA Bull 1.5X Shares (TSLL), the largest single-stock ETF. Who is using these funds, and how are they being used? Ed Egilinsky, managing director at Direxion, sits down with etf.com's Sumit Roy to discuss. 

Sumit Roy: Hi, this is etf.com's Exchange Traded Friday's podcast, a weekly podcast covering developments in the ETF industry. My name is Sumit Roy, and I'm senior ETF analyst for etf.com.

This week I'm talking with Ed Egilinsky, who is managing director at Direxion, an ETF issuer known for its leveraged and inverse funds. Ed, welcome to the show.

Ed Egilinsky: Thanks for having me today.

Roy: Absolutely. So Ed, I want to start by talking about single-stock ETFs. When these were first introduced to the market, there was a lot of skepticism about them. But if you look at your Tesla fund, it's on pace to be a $1 billion ETF, which is obviously super impressive. What's driving that?

Egilinsky: Well, I think in the case of Tesla, it's a polarizing stock. Both sophisticated retail clients and institutions like to trade it. In fact, a couple of months ago, for Tesla, the common stock volume for a given day was greater than SPY.

So there's always continued interest there. And that is the leading pair of single stocks, leverage and inverse single stocks within our lineup. We have a 1.5x bull and a nonleveraged inverse bear, not just with Tesla, but with total of five megacap stocks: Apple, Amazon, Google and Microsoft as well.

So these are some of the biggest market cap stocks that people want to trade, whether it's to the long side or to the short side.

Roy: Makes a lot of sense. And taking a step back, I'd love it if you could explain who single-stock ETFs are designed for and all the different ways that they can be used.

Egilinsky: They're really designed for short-term active traders that want to express a short-term view on one of those individual stocks, whether they want to have leverage on the long side, or if they feel that the stock might reverse course and go down for a short period of time, they could trade our nonleveraged inverse bear products.

In terms of who's utilizing these, if you have maybe the inability to get margin in an account and with interest rates rising, that could be more costly.

Here's a cost-efficient way from a short-term perspective, if you want to employ some leverage on those individual stocks to the long side. And from a short perspective, with a lot of clients, it's difficult to short outright within an account. You could have unlimited liability; in that case, their borrow costs.

So through a packaged ETF now, you have the ability to take a bearish position on an individual stock. They still need to be monitored day to day.

Most of you out there that have ERISA accounts, you couldn't previously short an individual stock on a case-by-case basis, you might be able to with one of our nonleveraged ETFs.

And for those individuals, whether it's institutional clients or sophisticated retail that have embedded gains in one of these, individual stocks may use the nonleveraged inverse bear to hedge those taxable gains.

For those taxable accounts that don't want to generate some taxable gains, here's a way to possibly hedge.

I would preface it, though, by saying that they should check with their CPA to determine what's appropriate for them.

Roy: Great. So it sounds like there's a lot of different use cases for these ETFs. It's not just about speculation, but you did mention an interesting thing, which is these are cost efficient.

I looked at the interest rates on margin loans recently, and they're something like 5%, 6%, even 7%, depending on your broker.

So when you buy a leverage ETF like TSLL, it doesn't have those same costs associated with it; is that right?

Egilinsky: Well, there are costs. Keep in mind, most of our products are 95 basis points in the case of the single leverage and inverse. So they are more costly than a typical cheap beta ETF.

But these are designed, as you referenced, as short-term trading vehicles.

So to get that leverage or to have the ability to short in a package ETF certainly is an efficient way to do so and might be, on a relative basis, a little less costly than other options available to you to institute those type of trades. But there are costs associated with this.

I think the most important thing for somebody trading these is understanding the mechanisms of how they work.

That the fact is, after you own these, for a period longer than one day, there is going to be tracking and compounding that takes place that could work for or against you.

So these are vehicles where the timing matters, and the underlying, in this case, stock, the way it trends, matters; it will influence your return over time.

For example, Tesla this year, for the most part, that trend, of course, has been to the upside. And the Tesla stock as a result is over 100%.

In the case of since the fact that this is trended, if you own the one and a half times bull Tesla TSLL, you're actually up more than one and a half times the underlying stock cumulatively over the period because of that trend working for you.

Unfortunately, if you did our nonleveraged short TSLS, you're still down significantly, but not as much as you would have been. Of course, you would have been to zero because the stock's over up over 100%, TSLS.

Because of compounding, you're down about 60%, which is still pretty significant for clients to realize that there is commensurate downside risk.

That's where compounding can work for you, but compounding also can work against you, where you can lose more than that three times, for example, when you hold it past one day.

So you’ve got to monitor these on a day to day basis. The timing matters. These are designed as short term trading vehicles for clients.

Roy: Makes a lot of sense. Very important information for investors to know. So obviously, the Tesla ETF is seeing a lot of action. But you mentioned you have other ETFs tied to other megacaps. Are you seeing activity in those other funds?

Egilinsky: Yes, definitely. You have a lot of regulatory news recently with Google and Microsoft, Microsoft on the Activision acquisition, Google with the EU in terms of what's going on with their ad tech business.

So a lot of people like to trade off of those type of headlines, whether they think the trend is going to go up or down. A lot of trading pre- and postearnings with these individual stocks.

And keep in mind this year the megacap stocks have led the rally in the market, including the five pairs that we have.

All five of those stocks this year are up more than the Nasdaq-100 or the S&P 500. So it's been a narrow breadth of stocks that have propelled this market.

Here's a way for people to trade that from a leverage standpoint on the bull side. But also there could be some contrarian plays. Tesla is just coming off of 13 straight days of being up.

Maybe it's overextended short term, so some traders might look to trade the countertrend of that with TSLS.

But there's a lot of headlines with these stocks on a continuous basis, and this is designed for those individuals that want to trade off of those headlines.

Roy: For example, Ed, Apple just had this really big event where they unveiled the Vision Pro, which is this virtual reality mixed reality headset. Are you seeing any interest in the Apple ETFs on the back of that announcement?

Egilinsky: Definitely, both to the bull and bear side.

I guess people are “sell on the news” in some cases, and some people are more optimistic from a short-term perspective based on their announcement and the fact that at some point it could generate some revenue to their bottom line.

And from the broader megacap leveraging inverse single-stock ETFs, certainly the buzz of AI has caught the eyes of some of the other single-stock pairs, like Google and Microsoft, which are competing with the ChatGBT for example, whether it's Bard or Bing for example. The AI interest this year is definitely resonating in some of the other pairs as well.

Roy: Absolutely. So we’ve seen a lot of success with single-stock ETF so far, much more than I thought we'd see, and we've seen a lot of launches, but we've also seen some closures when it comes to single-stock ETFs as well.

Is that the way it's going to be? You're just going to launch a bunch of products and see what sticks and then shut down the ones that aren't gaining traction?

Egilinsky: Keep in mind we launched some of the more highly traded, most liquid stocks. In fact, four of the five pairs that we launched are all $1 trillion-plus in market cap. Tesla with its recent run is probably about $800 billion now.

But you're always going to have opens and closures of funds. Not just with us; with any ETF provider. It depends on the individual stock and the beta associated with it.

We've tended to see that higher-beta type of stocks might attract more interest, or stocks like the megacap stocks that are continuously in the news that people want to trade off of. But of course we'll continue to innovate and launch products, but at the same time realize some ETFs over various market cycles. If they don't generate interest, there's a potential to close those.

Roy: Let's talk about some of your other funds. One thing that stands out to me is how SOXL, the 3X Bull Semiconductor ETF, has seen $1.7 billion of outflows, while SOXS, the 3X Bear Semiconductor ETF, has seen $1.6 billion of inflows.

As we all know, semiconductor stocks have performed remarkably well this year. Is this a case of speculators betting against the rally and getting it wrong, or is this hedging activity?

Egilinsky: Well, I think there might be a little hedging activity from a short-term perspective, but more so, I think it's hopefully traders taking profits.

Semiconductors is probably one of the leading, if not leading, tech industry year to date as a group. So we're just not seeing this in our pairs with SOXL and SOXS, we're seeing it with some other of our triple leverage products as well, where we've seen net outflows on the long side, especially when something's trended higher, clients taking some profits from a trade and then initiating some short positions, thinking there might be some short-term reversals there.

And as you know, SOXL is our largest leverage inverse ETF. It just eclipsed over $7 billion. SOXS is over $1 billion as well.

These are designed to be short-term trading vehicles. As I said, look at the daily volume of trading with SOXL and SOXS. You could have a turnover of our total assets of trading sometimes within a couple of days or even in a day or two or three. And that's what they're designed for.

And I think that illustrates that the active daily trading volume of our leverage and inverse ETFs in general, just illustrating further that these should be utilized as short-term trading vehicles.

Roy: It looks like certainly investors are using them as short-term vehicles. Another interesting product of yours that's seen demand this year is TMF, the 3X Long Bond ETF.

Looks like a lot of people are betting on the Fed's rate hikes ending soon and potentially bonds rallying on the back of that.

Egilinsky: Well, we've seen a significant amount of inflow periodically throughout the year in TMF, and that's the triple leverage of the 20-plus-year Treasury.

And we use on the long side physical TLT, the ETF that a lot of people probably know out there, and what's called the swap, which provides the leverage for us on TLT.

We also have TMV, which is the bear triple leverage.

But when you look at it this year, people are presuming that the Fed is going to ease at least the rate hikes. They did pause this month.

We tend to see a lot of activity pre- and post-Fed meeting traders looking to take advantage of that in either direction.

But the heavier flows this year have been for the most part on TMF looking for rates to go down.

But again, illustrating the nature of why these are short term at the beginning of the year, that was a good trade. Lately, that has not been a great trade in terms of interest rates starting to rise again over the last couple of months.

Roy: Interesting. Before I let you go, Ed, I want to ask you about the future of Direxion. You have a lot of interesting products. What can we look forward to in the future?

Egilinsky: Well, continued innovation, looking for different ways that we could provide leverage and inverse exposure to that active trader out there.

So different types of exposure, maybe, that are just not out there at present, or to do some things where there's an opportunity to further, no pun intended, leverage some of the success we've had with other types of ETFs that are in the marketplace.

On the nonleveraged thematic side, we're always looking for ways that we could differentiate ourselves from a crowded marketplace.

And certainly our QQQE, which is our equal weight Nasdaq-100, as I mentioned earlier, with the narrow breadth of stocks basically generating most of the return of the major indices this year, we're seeing a lot of interest in our nonleveraged equal weight Nasdaq-100 QQQE.

And we also have a commodity strategy that's unique in nature. It's a broad commodity basket. It's not static, always 100% long, and it's based on a set of rules. It'll be longer commodity or in cash with the commodity, depending on price trends. And that's our COM ETF.

So we're always looking for ways to bring more innovative products to the marketplace, both to the trader type of mindset as well as more to the strategic asset allocator where it makes sense.

Roy: So Ed, obviously when it comes to inverse and leverage ETFs, education is key. Investors need to understand how these products work. Where can they learn more?

Egilinsky: Our website in fact has a Leverage and Inverse Education Center.

I'd recommend anybody that is thinking of investing in leverage and inverse to go to our site, check out our videos and understand the mechanisms of how these work.

Before considering an investment, it's very important that people understand the compounding after holding these for more than one day before they commit to trading any of our vehicles. And that's really a focus for our firm on the leverage and inverse more than anything else, education; these are not appropriate for everybody.

And in fact, most investors that are more buy and hold, these are not going to be suitable for. These are really suitable for those sophisticated, active traders that want to express in a view short term on whether something's going to go up or down.

Roy: That's great. Well, we're going to have to leave it there. Ed, thanks so much for coming on the show and sharing your insights with our listeners. I hope you enjoyed this episode.

You can find this and all other exchange traded Fridays episodes on ETF.com or on any major podcast platform. See you next week.