Pair-trade ETF strategies raise questions on risk

Want to go long Bitcoin-holder MicroStrategy Inc. while shorting megabank JPMorgan Chase & Co.? How about buying streaming giant Netflix Inc. while dumping Comcast Corp.? Or pitting Google-parent Alphabet Inc. against New York Times Co.?

A flurry of potential new ETFs are offering to do all that — and more — as the retail boom for options-powered funds shows no sign of letting up. 

Tidal on Wednesday filed for eight new so-called pair trades — which go long and short on two opposing stocks — in the exchange-traded-fund wrapper and under a trademarked “Battleshares” tag. The investing rationales proposed include one that goes long AI-chipmaker Nvidia Corp. but shorts semiconductor stalwart Intel Corp., another does the same with Tesla Inc. and Ford Motor Co. The ETFs would, if launched, use a number of different tools to do so, including short sales of securities, swaps and options, according to the filing.

This year, upstart firms and mainstream Wall Street issuers alike have flooded the market with typically higher-fee ETFs offering souped up securities and derivatives products with differing leverage and return profiles. The conveyor belt of production has spat out any number of leveraged, inverse, buffer and covered-call ETFs that fall under the derivatives-based ETF umbrella. 

But the hype over these sometimes-riskier products, which are gaining favor with the retail crowd, has its critics. Industry insiders question the overabundance of offerings and wonder if retail investors understand all the risks involved. 

“Kudos for the ETF industry for always pushing the envelope, but some of the new launches seem to go against the value proposition of ETFs being diversified, inexpensive investments, to catering more towards the traders and speculators,” said Bloomberg Intelligence’s Athanasios Psarofagis. 

The issuers, for their part, say that their products are meeting investor demand — especially from the stay-at-home-trader crowd. Derivatives-based ETFs have boomed in the US, with firms launching more than 160 new funds this year. Assets have grown sixfold in the past five years to $300 billion, according to data compiled by Bloomberg. The fast-expanding category includes single-stock funds that offer juiced up or inverse returns on one company, to a growing number of yield-focused funds. Many retail investors are drawn to the promise of big payouts on volatile moves. 

Other Battleshares’ pairings include: crypto exchange Coinbase Global Inc. versus Wells Fargo & Co., weight-loss drugmaker Eli Lilly & Co. against Taco Bell-owner Yum! Brands Inc., and one that wagers on Amazon.com Inc. but looks for a decline in brick-and-mortar retailer Macy’s Inc. The paperwork didn’t specify how much each of the funds would charge. Michael Venuto, Tidal’s co-founder and chief investment officer, said the firm couldn’t comment on the filing. 

The Battleshares funds aren’t the first to test pair-trading strategies. In 2019, Direxion issued a growth versus value small-cap fund, a large-against-small fund and a cyclicals pitted against defensives strategy. All three were later liquidated. Meanwhile, a product from ProShares, launched in 2017 and long online stores but short brick-and-mortar-based ones, has just $9 million in assets. 

“We’ve seen success to some degree with leveraged single-stock funds — this is perhaps the next evolution of that with leveraged-pair trading,” said Todd Sohn, an ETF strategist at Strategas. “The tricky part, though, is finding a long and short trade that resonates with the trading community. On the surface, they make sense — but that can always change as market regimes come and go.”