Bitcoin Euphoria Poses Risk to These ETFs

Investors are flocking to turbocharged exchange-traded funds to capitalize on the momentum in bitcoin, but there are hidden risks that many people might not understand. These ETFs aim to amplify the daily return of MicroStrategy, a company that has become a bitcoin buying machine. By using complex derivative bets, these funds seek to offer double the daily return of the stock, both to the upside and downside.

However, investing in these funds is inherently risky. MicroStrategy itself is a leveraged bet on bitcoin, with around $35 billion of the cryptocurrency in its possession. The market value of the company has swelled to almost $90 billion, which is more than twice the value of the bitcoin it actually holds. Some skeptics argue that this situation is not sustainable.

Two of these ETFs, the Defiance Daily Target 2X Long MSTR ETF and the T-Rex 2X Long MSTR Daily Target ETF, were designed for investors seeking to take a more aggressive stance on the stock. With around $5 billion in assets collectively, these funds have seen significant growth since their launch in August and September.

Analysts suggest that the ETFs are contributing to the rapid rise in MicroStrategy shares. They warn that if the stock were to plummet by 51% in a single day, these ETFs could be completely wiped out—a scenario reminiscent of what happened with some volatility-linked ETFs during the 2018 market episode known as Volmageddon.

In recent days, the two 2X ETFs have not been performing as intended. For example, when MicroStrategy shares rose by 9.9%, the T-Rex fund only increased by 13.9% instead of the target of 19.8%. This discrepancy led to dissatisfaction among investors, some of whom took to social media to express their concerns.

One investor, Jesse Schwartz, used these funds to increase his exposure to the stock but was disappointed by the performance. Schwartz contacted his broker, Charles Schwab, and eventually sold all his shares by the end of the week due to feeling he wasn’t getting what was promised.

Overall, while these single-stock ETFs offer regular investors access to strategies previously reserved for Wall Street, critics emphasize that they can be risky due to the lack of diversification. In the case of the MicroStrategy funds, the leveraged exposure to a volatile stock and an unpredictable cryptocurrency adds to the potential risks. Critics warn that the hype surrounding these funds is part of a broader investor euphoria for speculative assets that could eventually end in a collapse.

Managers of the MicroStrategy funds attribute the struggle to hit the 2x targets to their prime brokers reaching limits on swap exposure. Swaps are a common tool used by leveraged ETFs to achieve their desired results, but the availability of these swaps for smaller, less liquid stocks like MicroStrategy can be limited.

In conclusion, while these turbocharged ETFs might seem like a shortcut to amplified returns, investors should be aware of the risks involved. The recent performance discrepancies and concerns raised by investors highlight the complexities and potential downsides of investing in these funds. It’s crucial for investors to thoroughly understand the mechanics and underlying risks of any investment before diving in.