What investors need to know about single-stock ETFs

The opportunity to reap quick short-term returns is attracting interest from ETF investors who are either bearish or bullish on a single stock.

But as the latest way to trade individual stocks takes off, there are key product components investors should keep in mind before committing.

THE DAILY RESET

Single-stock ETFs offer traders exposure to the daily performance of a single stock. TSLL, for example, gives bullish investors 1.5 times daily exposure. TSLS is for bearish investors to get 1X the yield of Tesla.

At the end of the day, it resets. It then starts again the next day.

“There is a swap that is used to leverage all ETFs and certain counterparties, Reggie Brown, head of GTS, told Bob Pisani on CNBC’s “ETF Edge” on Monday. “Some ETFs have five different swap counterparties to reduce risk for individual investors.

Brown said that leveraged ETFs are backed by a swap, A strike price, or time limit, is the end of the leverage. But ETFs always trade after the limit period when the swap is hit and reset.

“It’s important to understand when the reset is happening and what the uncovered periods are,” Brown said. “And then the next day, what happens.”

For investors who hold their product for several days, Brown said they will get the reset effect, or gamma.

“It resets inside,” he said, “and you don’t get the full return.”

SWAP COUNTERPARTY RISK

GraniteShares CEO Will Rhind said counterparty risk is a valid concern when it comes to a swap, a bilateral contract between two parties.

“The risk is, whatever the counterparty, if it goes bankrupt, it will affect the value of the ETF,” Rhind said Monday on CNBC’s “ETF Edge.”

The counterparty is usually an investment bank, Rhind said. He used Lehman Brothers during the financial crisis as an example.

“There were a few notes issued on the exchange that were canceled or refunded as a result of this,” he said. “People have lost money, so that’s a concern.”

But because single-stock ETFs are meant to be held for a short time, Rhind said counterparty risk is generally not a high level of concern for investors.

“You can trade it in,” he said.

TEST VOLATILITY

There are currently single-stock ETFs for Tesla, Apple, Coinbase, Nike, Pfizer, Paypal, and NVIDIA. Brown said issuers will not keep product in the market that is not received by acquiring assets.

“Generally, stocks that have high conviction, high beta, and high volatility are likely to be the ones you’ll see priced the most in a leveraged or inverse single-stock structure,” Brown said.

Direxion, for example, recently launched a suite of single-stock ETFs that revolve around Tesla and Apple. Dave Mazza, managing director and chief product officer of Direxion, said filings for other titles are in the works, particularly for some of the mega-cap names.

“Right now we’re really focused on getting some of these big names that have depth of volume and liquidity around them,” Mazza said, “so that we’re in the best position for the both create ETFs and manage them as day-to-day trading tools.”

While volatility and volume are key to identifying a stock that can work as an ETF on its own, Rhind said it must also be commercially viable.

“The question we always get asked is ‘can you do it on Gamestop or AMC?’ Rhind said: “And so far the response has been that it’s too volatile.”

Regulatory rules on how products can be launched guide the decision-making process and the amount of leverage offered, Rhind said.

“Some stocks are just too volatile and couldn’t calculate with this rule,” Rhind said. “And going back to the reset with profits reinvested every day with rebalancing at the end of every day, there are stocks that are just too volatile.”

Single-stock ETFs first launched last month, so demand levels for the products and their continued sustainability are choppy at the moment. And as commodities accelerate, Brown said innovation expands the ETF industry.

“It’s the right things, getting investors into the market,” Brown said. “But having a clear view of investment tools versus trading tools as we move forward with innovation is probably the best practice we can put in place.”

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