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Exploring The Leveraged ETF Trade Heading Into Earnings Season

The second quarter earnings season is upon us, meaning traders and investors are primed to take advantage of volatile moves in stocks.

There are many ways to trade a stock before and after it reports earnings. Traders looking to keep it simple can buy or sell a stock outright, or they can use options if they want to risk less capital or hedge themselves.

Many institutional traders use multi-faceted strategies that involve several different instruments when trading around an earnings report. Oftentimes this involves one vehicle for the main part of the trade and another to hedge. Among the most common hedging tools used by institutions are leveraged ETFs, which are built to deliver multiples (or inverse multiples) on a given index. Leveraged ETFs are popular as short-term trading instruments and, more tactically, as hedges due to their heightened risk-reward structure.

“They aren’t meant to be held for more than a few days at a time,” Sylvia Jablonski, managing director of leveraged ETF provider Direxion ETFs said. “Leveraged ETFs are trading tools that should be used as part of an active trading strategy.”

Over time, all leveraged ETFs will trend lower than their state objective because of the daily rebalancing required to maintain leveraged exposure. While traders can still rely on a short-term chart to provide some insight into a fund’s recent price trend, another way to measure a fund is to look at fund flow. The fund flow tool at ETF.com is a great resource for this.

A lot of inflows into or outflows out of a specific leveraged ETF may not tell us which way traders are leaning—since they could be using it as a hedging tool—but it can tell us that traders are confident in the fund’s ability to deliver on its short-term objective. It can also paint a picture of how traders are changing their strategies to react to macro news.

For example, Jablonski noted that a pair of bullish funds, the Direxion Daily Energy Bull 3X Shares (NYSE: ERX) and Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 3X Shares (NYSE: GUSH) rallied in April and May with the rise in oil prices. But when the trend reversed in June their bearish counterparts saw inflows as people flipped sides.

“When traders are coming in and buying the bull fund and the index trends for two days, and you see them selling out of it and you see the assets in the bear fund go up, it tells us people are using the products the way they hoped they would for short-term trading,” she said.

Jablonski added that, with technology and healthcare earnings on deck, funds like the Direxion Daily Technology Bull and Bear 3X Shares (NYSE: TECL) (NASDAQ: TECS) and Direxion Daily S&P Biotech Bull and Bear 3X Shares (NYSE: LABU) (NYSE: LABD) will likely see volatile flow and price activity.

Elsewhere, Jablonski noted that money has recently flown into leveraged emerging and developed market funds.

“I would think that emerging and developed would be awesome opportunities right now. We’re seeing those markets pullback on news lately, the biggest pullbacks we’ve seen in a while, but longer term the prospects of growth and economic recovery are probably pretty high in developed markets and emerging markets,” she said. “They’re certainly not overvalued.”

Direxion is a content partner of Benzinga

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