Will ETP Derivatives Help Individual Investors?

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Photo Credit: InvestWithAnEdge.com

The first exchange-traded product to list in the United States will be launching soon.  Its goal is to track the changes in price of American real estate with a leverage of 300%.  The new products are very much like derivatives, having zero investments in their “underlying index” and instead using capital shifting measures to make the ETPs trade like ETFs.

Tracking Housing with Treasuries

Housing and treasuries have very little in common, if not polar opposites.  Generally, when treasury prices are high, housing prices are falling and vice versa.  However, the new fund from MacroShares will use treasury bonds to back its index and offer a way to track the housing index through a complex shifting of capital from one exchange-traded product to the other.  The fund will be based around the Case-Shiller Home Price Index, in which changes in the index will be multiplied by a figure of three and then adjusted to the exchange-traded product.  If the bullish fund is up 10%, the bearish fund will drop 10% to form a perfect zero sum game, minus the fees.

Setting the Stage

Should this new line of exchange-traded products take off, investors may have an even greater ability to track their favorite investments.  Unlike other ETFs which move the market based on where they allocate capital, the ETP will not interfere with market prices, making them suitable for avoiding the typical speculative bubble.  Other exchange-traded funds, such as the USO Oil Fund, are notorious for creating artificial spikes in the price of oil as the fund adjusts its holdings.  Were it to use a similar model as that of the MacroShares fund, the oil fund would play no role in manipulating the index, and as such, provide a better method for producing profits.

The Future to Come

The future of Wall Street could be similar to that of a casino, where no real holdings are exchanged, but instead investors buy and sell what are merely futures and not actual products.  Though this day is distant, if even existent, the possibility that traders will be trading other investments than just stock is certain.  New models built around higher leverage and extreme scenarios could be made more available to the general public, rather than just to investment banks and large players.

Derivatives Broke Insurance, But Will They Break Investors?

Derivatives were not the problem to the insurance companies; it was the extreme leverage that was utilized.  With zero sum exchange-traded products, you cannot have runaway losses or runaway winners as eventually one fund is worth zero while another is worth the value of both previous funds.  In this case, there is only the chance of 100% profitability, and with extreme leverage, there is some consistent top to the profits of small investors.  Though volatility is certain and should be expected, there should be little issue with these new products bankrupting the cautious investor.  The gambling types may have some concern as it would be possible to create funds leveraged to the maximum, although the overall profit and loss schedules would be minimized to losing it all or doubling up.

What’s Next?

It appears now that the institutions and big banks have access to products in the financial industry that ordinary investors cannot touch until decades later.  The derivatives market is nothing new; it’s been in existence for as long as banks have made bets with other banks.  If the current situation of the institutional investors is any indicator, the next step for the average investor is regulation, if it should ever trickle down to the individual from the corporate elite.  Either way, investors will only have more options to invest and new ways to produce profits – which is great for the future of investors as a whole.

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