Tag: etf

Picking the Right ETF to Avoid Contango

Posted on by Matt Thalman

Exchange-traded fund investors who buy and sell inverse products regularly know what contango is. But the average investor probably doesn’t understand the ins and outs of contango and how it can hurt an investment.

With a little knowledge, you can actually use contango to your advantage and profit from an investment that is actually losing value.

What is Contango?

In a nutshell, it is the cost of purchasing futures contracts, options, and derivatives. When you invest in a leveraged exchange-traded fund, in order for the fund to gain that 2X or 3X leverage, it must buy monthly futures and options contracts.

Then towards the end of the month, the fund will sell its current contracts with very near-term expiration dates and purchase the following month's contracts that have a longer expiration date. In the process of doing this, the fund will sell a lower-priced contract and then buy a higher-priced contract.

This occurs because the further out the expiration date on an options contract, the more expensive the contract will be. This is because the buyer of the contract has time on their side and the seller is taking on more risk because the value of the underlying asset has more time to make a large move.

Since the price of the further dated contracts is always more expensive than what the fund is selling their current contracts for, the fund is constantly burning money. This money burn, is called contango. The money being ‘burned’ is literally reducing the amount of money the fund has to invest and, over time, causes the price of the ETF to slowly shrink. For example: a $25 ETF will only be worth say $20 over the course of a few months, even if the underlining investments that the fund tracks stayed absolutely the same during that whole period of time.

On a one-day basis, contango isn’t usually seen or felt by investors, but over the course of a few weeks or even months, it would definitely be felt.

How to Make Contango Work For You

One method of taking advantage of this contango money burn is too ‘short’ the different ETFs that experience this phenomenon. However, shorting stocks may not be in the cards for all investors because it is risky and capital intensive, especially when you are trying to short an investment over a long period of time.

Another, slightly lower risky way and with substantially lower capital outlays, is by purchasing put options in ETFs that experience high levels of contango. Buying put options is just slightly less risky since straight shorting a stock can actually end up costing an investor more than a 100% loss.

With put options, your max pain is 100% loss. If you short a stock and the stock runs higher, you could actually lose more than 100% of your initial investment since the stock price has no cap. Options are still risky, but again just slightly less risky.

So how does that work? Let’s say you want to short the Invesco QQQ Trust (QQQ), essentially the Nasdaq index. But you don’t want to just short it, you really believe it is heading lower so you want a little leverage.

You find the ProShares UltraPro Short QQQ ETF (SQQQ). This is an ETF that is 3X short the QQQ or the Nasdaq. The SQQQ will go higher in price when the Nasdaq goes lower. However, the SQQQ experiences contango due to the way it produces its 3 times leverage.

Now the ProShares UltraPro QQQ ETF (TQQQ) is the opposite of SQQQ. It gives investors 3X leverage to the upside of the Nasdaq or the QQQs. If you have a strong conviction that the Nasdaq is heading higher, the TQQQ is for you. But once again, contango will have an effect on your TQQQ returns if you hold it for more than one day.

Your option to not only avoid contango but also to make it work for you is to buy put options contracts in the TQQQ or the SQQQ depending on which way you think the Nasdaq is going to go.

The way these work is buying put contracts on the opposite ETF than the way they are designed to move. If you think the market is heading higher, you would normally buy the TQQQ ETF. But if you want to avoid contango, you actually buy the SQQQ put options. This is because if the market goes higher, the SQQQ will lose value and at the same time contango will be lowering the price on a daily basis just slightly.

Now if you think the Nasdaq is going lower, you would buy put options on the TQQQ, since this ETF will go higher if the market goes higher and lower if the market falls.

I am just using TQQQ and SQQQ as examples, but you can do this with any leveraged ETF that is going to experience contango. Also, you need to remember, contango will only affect an ETF's price if you are holding the ETF for a period longer than one day. And even if you hold it for just a few days, the effect will not typically be noticeable. This strategy is going to produce the best results if you plan to own the put options for a few weeks or months.

Matt Thalman
INO.com Contributor
Follow me on Twitter @mthalman5513

Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published, but he does buy and sell put options in the TQQQ and SQQQ ETFs from time to time. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.

Zero Fee Trades Likely Means Lower Fee ETFs - Part 2

Posted on by Matt Thalman

Now that its clear investors understand how fees affect their returns and the financial industry as a whole is responding by lowering trading commissions to zero and cutting management fees on funds, its just a matter of time until we see ‘indexed’ funds begin to offer zero or near zero, as in 0.01% expense ratio, fee funds.

Why? Simple because they have to stay competitive if they want to stay in business.

For years the biggest argument for one someone would buy an index fund is because it would be so cumbersome and costly to go out and buy a few shares of all the different stocks that make up a specific index. For example, if an investor wanted to mimic the Dow Jones Industrial Average, they would need to go out and buy one share of each of the 30 companies that currently make up the index.

In the past, that would be 30 different stocks in someone’s personal portfolio, which honestly isn’t that much higher than what the average retail investor owns, typically somewhere between 15 and 20. However, that would also mean the investor would have paid a trading commission 30 different times in order to set up that portfolio (1 trading commission for each different company they bought a share or multiple shares of). If the average investor was paying $4.95 per trade, that’s $148.50 in trading commissions just so they could mimic the Dow Jones Industrial Average without having to pay a mutual fund or ETFs fees every year. Continue reading "Zero Fee Trades Likely Means Lower Fee ETFs - Part 2" →

Zero Fee Trades Likely Means Lower Fee ETFs - Part 1

Posted on by Matt Thalman

The investment world was flipped upside-down recently when Charles Schwab eliminated trading commissions on stocks, ETFs, and options last month. The move prompted TD Ameritrade, E*TRADE, and other players in the industry to follow suit quickly or risk losing clients. The move is not the first time we have seen trading commissions reduced, but never before have retail investors been able to trade literally for free.

Most people would claim that the late Jack Bogle started this ‘war on fee’s’ decades ago when he introduced the low-cost index fund at Vanguard. The first low-cost mutual funds offered investors an inexpensive, at the time, option for investors. The low fee option Vanguard introduced proved to be a good move as Vanguard grew its asset base into what is now more than $5.5 trillion. Over the years, other firms began to fight back by cutting their fees, but the war had already started, and investors began to see the value in low-cost options.

Jack Bogle himself would often talk about how fees cost investors hundreds of thousands of dollars over their investing lifetime. The simple idea of paying lower fees equates to higher account balances over time makes perfect sense, especially to anyone who understands the power of compounding returns.

Zero fees on trading commissions will leave millions of dollars in investors' hands. It has been estimated that Charles Schwab alone will lose out on somewhere between $90 and $100 million in quarterly revenue now that they cut their trading fee to zero. That is just $100 million for one firm and one quarter. Based on those figures only of Schwab, we could easily see somewhere close to $1 billion is left in the hands of investors over the course of a year.

Now that we have hit zero fees on trading commissions and investors continue to learn how low-cost investing helps their overall returns, it's likely we will see more fee-cutting throughout the investing industry. The high fee’s on mutual funds have already begun pushing investors to ETFs. And the ETF industry has already started fighting the battle to cut costs. Continue reading "Zero Fee Trades Likely Means Lower Fee ETFs - Part 1" →

Political Policy Changes Redefining One Industry and Creating Massive Opportunity

Posted on by Matt Thalman

Matt Thalman - INO.com Contributor - ETFs


This summer investors have witnessed firsthand how political policy changes can affect commodity and equity prices. In July both France and the United Kingdom announced it would ban the sale of diesel and gasoline powered cars by the year 2040. Other countries like Norway and India have set goals of even earlier dates to no longer have oil based vehicles sold by 2025 and 2030.
India had even taken it one step further and announced that not only will gasoline vehicles not be sold after 2030, but all gasoline vehicles will need to be replaced with electric and battery powered vehicles by that year.

The Netherlands wants to switch to electric vehicles by 2025 while Germany intends to make the change by 2030, but neither has set these plans in written law. But, the most notable announcement comes from China, a country that has over 300 million registered vehicles. Chinese authorities have not yet set a deadline for the end of sales of internal-combustion vehicles, but they have made it clear that they are working on a timetable.

While the U.S. and some of the other leading countries around the world have yet to come out and formally announce a date of when internal combustion engines will no longer be allowed, many believe there will come a day that all first world countries have such a ban.

So from an investing perspective, cashing in on this opportunity is simply just buying investments today and waiting. Continue reading "Political Policy Changes Redefining One Industry and Creating Massive Opportunity" →

3 ETFs 20 Somethings Should Buy

Posted on by Matt Thalman

Matt Thalman - INO.com Contributor - ETFs


There has never been a better time to be an investor. No Matter your age, investing experience, investing temperament or income level, there are a number of investment options that are right for you. I recently wrote a piece discussing a few of my favorite Exchange Traded Funds geared for all investors. Most investors should buy a few of the ETFs I mentioned in the piece or ETFs similar in nature and be set. But, after writing that piece, I began to think about how different age groups have different interests and different goals with their money and may want to further diversify their holdings based on their personal preferences.

So with that in mind, today we will be talking about three ETFs that investors in their 20's would be interested in. But before we get any further, everyone should remember the ETFs mentioned in the previous piece should still make-up a portion of your investment able assets, simply due to their stability and diversity. Continue reading "3 ETFs 20 Somethings Should Buy" →