The Pros And Cons Of Factor Shares ETFs

The newest and arguably most complex ETF products are the Factor Shares spread ETFs. Factor Shares has launched a family of 5 spread ETFs.

• 2X: S&P 500 Bull / T bond bear (FSE)
• 2X: S&P 500 Bull / U.S Dollar bear (FSU)
• 2X: Oil Bull / S&P 500 bear (FOL)
• 2X: Gold Bull / S&P 500 bear (FSG)
• 2X: T bond bull / S&P 500 bear (FSA)

These ETFs are interesting, because they let investors bet on the spread between two investments.

Strategy Analysis

• FSE: Being long the stock market and short the bond market is an interesting trade, but at the end of the day this trade is nothing special. Stocks and bonds move inversely, so with FSE investors are betting "risk on." Buying FSE is like buying a high beta stock or leveraged bullish ETF.
• FSU: Nothing special for same reasons why FSE is nothing special. S&P 500 and U.S. dollar usually move inversely. However this could be a interesting short term trade because it is possible that the dollar goes higher and stock market higher in the short term as discussedhere.
• FOL: Finally an ETF that offers something new and different. Being long oil and short the stock market actually seems like a good idea. The "risk on" "risk off" trade is not really in play here. If things for the global economy get bad then both oil and stocks will go down. If things for the global economy are good then both oil and stocks will go up. However, it is possible that oil spikes and the stock market goes down. For example, volatility in the middle east could lead to a spike in oil and a dip in stocks. This ETF would be a major winner in such circumstances. This ETF is worth considering to diversify a portfolio.
• FSG: This ETF is also interesting, because gold and stocks tend to move together over time. Investors who believe that central bankers "money printing" will fail to help the global economy, but increase inflation should buy this ETF. Under such circumstances, gold will outperform stocks. I discussed FSG in more depth here.
• FSA: This ETF is not interesting as it is simply another way to be "risk off." Anyone who thinks the macro trade will go lower should go short stocks via leveraged ETFs (SPXU, FAZ, QID) or long bonds through leveraged ETFs (TMF)

Liquidity Concerns

One important thing to consider before investing in these new products is liquidity. At this time, most of these ETFs have very little volume on a daily basis. The ETFs' 10 day average volumes are listed below.

FSE - 2,100 shares
FSU - 753 shares
FOL - 4,200 shares
FSG - 53,300 shares
FSA - 1,000 shares

These securities (with the exception of FSG) are simply not liquid enough to place large bets. However, this could change if these ETFs become more popular among traders in 2012. If you are going to buy one of these ETFs, then do so using a limit order. Without real liquidity, it becomes dangers to place market orders as there is likely to be a huge gap between the price you pay and what it's worth. A better way to bet on a spread for now could be buying 2 different ETFs in the same amount. For example, instead of buying FSG, investors could buy both (UGL), 2X gold etf and (DXD) 2x inverse Dow Jones Industrial Average. This trade as well as the aforementioned trades in spread ETFs involve leverage. Leverage brings into play a host of other issues that are discussed here.

Conclusion

These new spread ETFs are interesting, but not yet worth buying. Without sufficient liquidity, these products are not worth buying. However, investors should continue to monitor daily volumes to see if more liquidity enters the space.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.