Bitcoin mania poses a risk to these ETFs
To take advantage of the bitcoin surge, investors have flocked to two exchange-traded funds that are boosted, but they come with unspoken risks. The software company MicroStrategy has become a bitcoin buying machine, and the ETFs aim to increase its daily return. They seek to provide twice the stock’s daily return, either upward or downward, through intricate derivative bets. The funds are hazardous by nature because they are from asset managers Tuttle Capital Management and Defiance ETFs. MicroStrategy, which owns about $35 billion worth of bitcoin, is a leveraged gamble on the cryptocurrency. However, its market value has increased to about $90 billion, more than twice the amount of the bitcoin it owns, thanks to enthusiastic investors. This is unsustainable, according to critics.
The T-Rex 2X Long MSTR Daily Target ETF and the Defiance Daily Target 2X Long MSTR ETF were created for investors who wish to wager on the stock with even greater vigor. Since their respective August and September launches, the two funds’ combined assets have grown to approximately $5 billion. According to several analysts, the funds are fueling the ferocious increase in MicroStrategy’s stock price. They caution that the ETFs might be totally destroyed if the stock fell 51% in a single day, a scenario that is comparable to what happened to some volatility-linked ETFs following the 2018 market event known as Volmageddon. In addition, the two 2X ETFs haven’t been performing as planned lately. On Wednesday, MicroStrategy’s stock increased 9.9%, but the T-Rex fund only increased 13.9%, falling short of the 19.8% target. As the stock fell, the fund’s performance also fell short. On November 25, when MicroStrategy plummeted 4.4%, its share price sank 10.7%.
Social media investors were outraged by the performance, questioning the disparity and expressing a sense of deception. The money has been used by Jesse Schwartz, a 36-year-old winemaker and day trader in Washington state, to increase his stock exposure. The fact that the shares weren’t doing as promised shocked him. Unsatisfied with the explanation, Schwartz called his broker, Charles Schwab, to inquire about the disparity. By the end of the week, he had sold all of his shares. “To put it mildly, it’s disappointing,” Schwartz remarked. “I’m not getting rewarded on the upside, and I’m taking on more risk on the downside.”
Since single-stock ETFs were first authorized by regulators in 2022, niche fund managers have introduced dozens of them. The funds have mostly performed as promised up to this point. Because they employ financial contracts called total return swaps, well-known funds that seek to double the daily return of Nvidia and Tesla typically track quite closely to their goal. The funds’ proponents claim that they provide ordinary investors with access to Wall Street’s long-standing tactics. Critics contend that because they don’t provide diversification, they may be harmful. The MicroStrategy funds, in this instance, provide leveraged exposure to a stock that fluctuates in tandem with an unstable cryptocurrency. They caution that the fervor is a component of a larger investment frenzy surrounding speculative assets that may ultimately implode.
According to the managers of the MicroStrategy funds, their prime brokers—companies that lend money for securities and other services to professional investors—may be having trouble meeting the 2x targets since they have reached the maximum amount of swap exposure they are prepared to supply. Swaps, which are generally accessible for the largest, most liquid stocks, are usually used by leveraged ETFs to achieve their intended outcome. Swap contract payments enable a fund to precisely double the daily performance of a stock or index and are closely linked to the performance of an underlying asset.
The manager of the Tuttle Capital and Rex Shares 2x long MicroStrategy fund, Matt Tuttle, stated that he is unable to obtain nearly as many swaps as he requires for his thriving fund. He claims that while he could have needed $1.3 billion last week, his prime brokers are now providing him $20 million to $50 million in swaps. Tuttle and Sylvia Jablonski, the CEO of rival Defiance ETFs, both stated that in order to attain leveraged results for their MicroStrategy funds, they are now using the options market. Although analysts claim that options are more of an imprecise science, traders can efficiently use them to quadruple an asset’s daily return. The market can be moved by large buyers like ETFs, and options prices fluctuate. According to Tuttle, the main cause of the deterioration in tracking is the usage of alternatives.
On November 25, the Defiance ETF experienced a decline that was over three times greater than that of the underlying stock. It dropped 1.76% on Friday, while MicroStrategy only saw a 0.35% decline. The launch of leveraged MicroStrategy ETFs, according to analysts, has sped up stock movements. In order to attain a leveraged result, the ETFs must alter their exposure daily. To reduce their exposure, the network of market makers that provide swaps and options frequently purchases or sells real MicroStrategy stock. It’s similar to placing a lead weight on your foot when operating a motor vehicle. “The default mode is going to be floored,” said Dave Nadig, a veteran of the ETF business who formerly worked at VettaFi and FactSet. “You can still deal with the gas.”
