Why ETFs Play A Role In Market Volatility

Are high-octane, leveraged exchange traded funds (ETFs) to blame for the wild moves in the last hours of trading?

The market’s volatility has been amplified in the last hour or so of the trading day for much of this year.  A report published by Credit Suisse, indicates that an average 26.2% of trading volume in the S&P 500 stock index took place in the final hour of trading and 17.1% in the last 30 minutes. This surge in trading has come amid big swings in prices of 3% to 4% in the last hour, states Tom Lauricella, Susan Pulliam, and Diya Gullapalli of the Wall Street Journal.

Some believe that volatility is caused by the use of leveraged ETFs. These ETFs, shares of which are created by using swaps or options, offer an upside or downside which is two or three times that of the actual fund.

There are currently more than 100 such ETFs to choose from and are one of the most actively traded securities in the market.  They are used by traders, hedge funds, and the average Joe Blow.  In fact, over the last three months, ProShares UltraShort S&P 500 (SDS) has been averaging a trading volume of 60 million shares per day and ProShares UltraShort Financials (SKF) averaged a whopping 27 million shares per day.

Others believe that ETFs have no direct impact on this volatility. Instead, it can be accounted for because of redemptions in large mutual funds and the unwillingness of market makers and traders to keep open positions overnight.

In the volatile month of September, it was quite common to see end of the day buying and selling of ETFs, determinant on whether or not the market was falling or gaining ground.  It is safe to say that ETFs play a pivotal role in the market.

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