NaughtyPines

TRADE IDEAS: THE 3X GOLD MINERS -- NUGT, DUST

AMEX:NUGT   DIREXION DAILY GOLD MINERS INDEX BULL 3X SHARES
241 2 2
To be honest, I'm not an incredibly big fan of leveraged exchange-traded funds, particularly those subject to contango. In uninformed hands, they present opportunities for huge gains, but also huge losses. DUST and NUGT             are both 3x leveraged instruments: DUST, a 3x bear ; NUGT             , a 3x bull . Here are a few important facts to know about these instruments:

(1) Both instruments are meant to replicate a factor of the daily movement of certain instruments using a variety of leveraging techniques, including derivatives.

The fact that they are shooting for "Daily" 3x movement and not something on a larger time frame suggests that these are not good "investment" vehicles, although I can see people wanting to dollar cost average in NUGT             small and over time to take advantage of splits the underlying undergoes from time to time. My guess is that, intratrade, you'd be in for a "rough ride" if you want to play these that way.

(2) The instruments and derivatives being utilized on any given day are somewhat "opaque." In other words, these funds' managers do not use a single index, instrument, or underlying, but may be using multiple underlyings and different derivatives of those on a given day to achieve fund goals. This is in stark contrast to an instrument like VXX             , which is a derivative of a single instrument and where a direct and useful relationship can be drawn between current VIX             "spot pricing", the pricing of VIX             futures in front months, and the existence of states of contango and backwardation that can form the basis for actionable trades.

(3) Because of this feature of these particular funds, it is basically impossible to cleanly or precisely chart a direct relationship between gold             prices and these instruments. However, NUGT             will move "generally" down when gold             prices move down; DUST will move up. However, they will not necessarily move 3x the movement of gold             , as the fund names suggest. They may move more; they may move less. (Friday, for example, XAUUSD             moved down 2.47%; NUGT             moved down 24.52%).

(4) Because these funds' managers use derivatives to achieve fund goals, both of these funds appear to be subject to contango and backwardation (See Split History). NUGT             price, over time, naturally declines with this effect; DUST, increases.

Because of this, my tendency would be to trade these instruments with "the contango flow", buying NUGT             or taking bullish assumption trades on "meaningful dips" and selling DUST on "meaningful rips." Although my take on these instruments is that they are meant to be "traded," rather than "invested" in, it's entirely possible for you to get caught in a trade longer than you would like. In that event, I'd rather be on the side of contango drift ... .

For this reason and in spite of the fact that these instruments do not enjoy a direct, clean relationship with spot gold             prices, I would nevertheless look at spot gold             prices and price action             before initiating a trade in either DUST or NUGT             , as opposed to using these funds' price action             to initiate a trade. This approach would be similar to my trading of VIX             derivatives where I don't look at the price action             of VXX             , for example, to enter, I look at VIX             instead in inform my entry.

Next: NUGT             -- Buy Shares or Sell Puts?

Comment: A correction is in order. When I look at the split history for NUGT, some of the splits are, in fact, "reverse" and some are in the "regular" direction, implying that, strictly speaking, a "contango" or "backwardation" effect may not be always in play.
It is not exactly clear what is the purpose of these ETFs. Aka who was the target customer. one would assume they are for extreme, intraday speculation by retail traders? Because most serious traders have a futures account an can achieve the same objective directly. But those retail traders are ephemeral as they lose their capital quickly and go away. So they question remains...
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Agreed. They're frankly "crappy products." For one thing, if you were going to set up this kind of product in order, in essence, to "beef up" the movement experienced by gold intraday, wouldn't you want to key it off gold prices directly, rather than off a group of companies that mine gold, some of which may be in various states of financial health? Certainly, these don't necessarily make trading gold any more "accessible" to the small account holder; NUGT was allowed to rip to $150/share before it's most recent split, which some would consider "pricey" for an underlying of this nature. The prospectuses indicate that they were only intended to replicate 3x daily movement of the involved underlyings; if you take that statement at face value, these instruments are potentially only intended for extremely short-term scalping, and we all know there are better, cleaner instruments to accomplish the intraday trade of gold where you actually "trade gold" -- not some poor substitute for it.
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