New Margin Requirements for Leveraged ETFs Whack Retail Investors but Don’t Address Ignorance

by Darwin on December 3, 2009

Did anyone notice a margin call in your account this week when you had a few thousand dollars in cash cushioning your portfolio the week prior?  I did.  I’ve had a proprietary trade on for some time now which employs leveraged ETFs overlayed with some other instruments for a market neutral play that’s been working out quite nicely.  I knew it was coming, but figured I’d wait for the margin call to come into effect to see just how much I had to unload in order to comply with the newly implemented FINRA regulations mandating higher margin requirements for leveraged ETFs.

To summarize, effective Dec. 1, 2009:

Beginning on December 1, 2009 margin requirements for leveraged ETFs increased dramatically from prior levels, with ranges from 50% for 2x long funds to as high as 90% for 3x inverse funds.

ETF Type            Old Margin    New Margin
200% Long               25%                 50%
300% Long               25%                 75%
200% Short              30%                60%
300% Short              30%                90%

Will these higher margin requirements benefit retail investors? Probably not.  It will just cost them more in margin expenses (for those that choose to use margin rather than cash as a buffer).  It also (like me) caused thousands of investors to execute trades this week that they would not have otherwise, which carry transaction costs of their own.  In effect, in a game of CYA, FINRA enacted a rule which was onerous for investors and did little to address the actual issue at hand – that retail investors often don’t know what they’re getting into and want to sue later.  These new regulations do nothing to address the latter, but rather just increase transaction costs for investors that do understand how these instruments work.

Here is a useful visual representation of just why these instruments are so risky over time and why they’re so darn misunderstood.

If, after reviewing the thoroughly understanding the risks and benefits of daily leveraged ETFs, you’re considering trading with them, check out the following resources:

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Fat Pitch Financials
December 7, 2009 at 9:39 pm

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1 Roger December 17, 2009 at 7:20 pm

That’s… unbelievably foolish. I can see the reasoning behind it (less likelihood that the investors will lose more money than they invest) but as you said, it does nothing to address the real problems, lack of knowledge and potential litigation.

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