Original title: Bitcoin Euphoria Threatens to Break These ETFs

Author: Jack Pitcher, The Wall Street Journal; Compiler: 0xjs@jinsecaijignore

Investors are flocking to a pair of turbines Boost ETFs to ride on Bitcoin’s momentum, but they carry hidden risks that are not widely understood.

These ETFs are designed to amplify the daily returns of MicroStrategy, a software company that has turned itself into a Bitcoin buying machine. They use complex derivatives bets designed to deliver double the daily returns on stocks - whether they rise or fall.

These ETF funds are managed by asset management companies Tuttle Capital Management and Defiance ETFs and are inherently risky. MicroStrategy itself is a leveraged bet on Bitcoin, holding about $35 billion in the cryptocurrency. But bullish investors have pushed its market capitalization to nearly $90 billion, more than twice the value of its Bitcoin holdings. Skeptics say this is unsustainable.

The Defiance Daily Target 2X Long MSTR ETF and the T-Rex 2X Long MSTR Daily Target ETF are designed for investors who want to bet more aggressively on the stock. Since their respective launches in August and September, the two funds' combined assets have swelled to about $5 billion.

Some analysts said that these ETF funds drove the sharp rise in MicroStrategy's stock price. But they warned that the ETFs could be wiped out if the stock fell 51% in a single day, a crash similar to what some volatility-linked stocks did after the 2018 market event known as Volmageddon. What happened to ETFs.

Importantly, these two twice-leveraged ETF funds (2X ETFs) have not performed as expected in recent days. On Wednesday, MicroStrategy shares rose 9.9%, but the T-Rex fund rose only 13.9%, rather than the expected 19.8% target gain. When the stock fell, the fund's performance was similarly disappointing. On Monday, when MicroStrategy shares fell 1.9%, the fund fell 6.2%.

The performance sparked an outcry on social media from investors who questioned the discrepancy and said they felt cheated.

Jesse Schwa, a 36-year-old Washington state winemaker and day traderrtz) has been using these funds as vehicles to expand its exposure to the stock.

Schwartz was surprised to find that the stocks did not perform as advertised. Schwartz called his agent, Charles Schwab, to inquire about the reason for the discrepancy, but was not satisfied with his agent's explanation. He sold all his stock over the weekend.

"It's disappointing, to say the least," Schwartz said. "I took more than all the downside risk and got no upside reward." Niche fund managers have launched dozens of single-stock ETFs since they first received regulatory approval in 2022. So far, the funds have performed largely as advertised. Popular funds aiming to double daily returns from Nvidia and Tesla tend to track their targets closely, thanks to their use of financial contracts known as total return swaps.

Backers of these funds say they give ordinary investors access to strategies long used by Wall Street. Critics argue that these funds can be dangerous because they do not provide diversification. In the case of the MicroStrategy ETFs, they add leveraged exposure to volatile stocks tied to unpredictable cryptocurrencies. They warn that the hype is part of a broader frenzy among investors for speculative assets that will eventually collapse.

MicroStrategy ETF managers say they may have trouble hitting their 2x target because of their top brokers, firms that provide securities lending and other services to professional investors. have reached the limit of swap exposure they are willing to offer.

Leveraged ETFs typically achieve their desired effects through the use of swaps, which are widely used on the largest and most liquid stocks. Swap contract payments are directly tied to the performance of the underlying asset, allowing the fund to precisely double the daily performance of a stock or index.

Matt Tuttle, who manages the Tuttle Capital and Rex Shares 2x long MicroStrategy funds, said he simply couldn't get the swap amounts he needed for his booming fund. He said his prime broker offered him $20 million to $50 million in swaps, when he could have used $1.3 billion last week.

Both Tuttle and Sylvia Jablonski, CEO of rival Defiance ETF, said they are turning to the options market to achieve leveraged gains in MicroStrategy ETF funds. Traders can effectively use options to double an asset's daily returns, but analysts say it's more of an inexact science. Options prices fluctuate, and big buyers like ETFs can move the market.

Using options is tracking evil, says TuttleThe main reason for change.

On November 25, the Defiance ETF fell nearly three times as much as the underlying stock. On Friday, the ETF fell 1.76%, while MicroStrategy fell just 0.35%.

Analysts said that the launch of the leveraged MicroStrategy ETF accelerated the trend of MicroStrategy's stock price. To achieve leveraged results, an ETF must increase or decrease its exposure on a daily basis. A network of market makers offering swaps and options often buys or sells actual MicroStrategy shares to hedge their exposure.

“It’s like putting a lead weight on your foot while driving. You’ll still have control of the accelerator, but the default mode will be floored,” said Dave Nadig, an ETF industry veteran formerly of VettaFi and FactSet. .