Betting Against The Small-Cap Rally

Small-cap stocks and ETFs are getting their mojo back. After lagging their large-cap peers for much of this year, U.S. small-caps started rallying in significant fashion in mid-August, a move that continued through the end of the third quarter.

The Russell 2000 Index, one of the most widely followed gauges of smaller U.S. companies, was iup 4 percent over the last week in September and 7.5 percent over the past month, bringing its year-to-date gain to about 11.5 percent.

As is often the case with short-term moves such as the aforementioned by the Russell 2000, some market participants are worried that this is too much of a good thing in too narrow a time frame. Judging by the recent treatment of some leveraged small-cap ETFs, some traders are wagering on near-term declines for the Russell 2000.

Leveraged Ideas

Among inverse and leveraged small-cap ETFs, two of the biggest names are the Direxion Daily Small Cap Bull 3X Shares TNA and the Direxion Daily Small Cap Bear 3X Shares TZA.

TNA attempts to deliver triple the daily returns of the Russell 2000 Index, meaning that if the Russell 2000 rises by 1 percent today, TNA should jump 3 percent. TZA, the bearish fund, looks to deliver triple the daily inverse returns of the Russell 2000, meaning that if the Russell 2000 falls by 1 percent today, TZA should rise 3 percent. 

Without the application of leverage, small-caps are usually more volatile than large-cap. Historical data confirm as much. That is to say, users of TNA and TZA should treat these products as short-term trades, not long-term, buy and hold investments.

Speaking Of Users...

As was noted earlier, the small-cap rally has some doubters, as the fund flow shows us. Over the past month, traders have been pulling an average of $10.8 million from TNA and over the past five days, the ETF's volume was 31.5 percent above the trailing 20-day average, according to Direxion data.

But wait. There's more. Treatment of leveraged of small-cap ETFs is not simply a matter of traders departing TNA. It also includes some of those traders cozying up to TZA.

Over the same 30-day period, TZA averaged $5.2 million per day of inflows and its five-day volume is 43.4 percent above the trailing 20-day average, according to issuer data.

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