Soaring Middle East Tensions Place The Spotlight Firmly On Direxion's DFEN ETF

Although the broader push for digitalization in theory should promote stability in international relations, cross-border rivalries and tensions have frequently spilled over into violence. The breaking news regarding Israel's strikes on Iran represents just the latest incident of armed conflict. With little to indicate that peaceful solutions are on the table for war-torn regions, the Dow Jones U.S. Select Aerospace & Defense has been one of the top performers this year.

According to an NBC News report, on early Friday local time, Israel launched strikes on Iran, targeting the nation's nuclear program. Adding to concerns of escalation in the Middle East, Israeli Prime Minister Benjamin Netanyahu stated that the operation "will continue for as many days as it takes to remove this threat." In response, stock futures tumbled, though not all sectors suffered the same fate.

In particular, the oil market has been booming in response to rising Middle East tensions. As well, the defense sector – due to a combination of pragmatic and cynical factors – has witnessed a spike in sentiment. On a year-to-date basis, the aforementioned aerospace and defense index gained over 23% of value. In contrast, the benchmark S&P 500 has gained less than 3% during the same period.

To be sure, it's not just the breaking news regarding Israel and Iran that's driving investor flows into the defense ecosystem. Per the Geneva Academy, there are more than 110 armed conflicts around the world, breaking down as follows:

Middle East and North Africa: More than 45 armed conflicts.
Africa: Over 35 armed conflicts.
Asia: 21 armed conflicts.
Europe: 7 armed conflicts.
Latin America: 6 armed conflicts.

Because these conflicts – such as Russia's ongoing invasion of Ukraine – provide no glimpse of an imminent endgame, the matter has prompted aggressive defense spending by international governments. In fact, a recent report by the Stockholm International Peace Research Institute (SIPRI) revealed that global defense budgets reached unprecedented levels last year.

The Direxion ETF: Although it's a contentious topic, it's an unavoidable one. Given the threat that adversarial nations can impose unilateral (and kinetic) actions against their neighbors, defense spending has become a priority. Subsequently, this dynamic boosts demand for the myriad enterprises in the war machine industry.

For traders simply following capital inflows, the Direxion Daily Aerospace & Defense Bull 3X Shares DFEN could represent an interesting platform. An ultra-leveraged exchange-traded fund, DFEN seeks the daily investment results of 30% of the performance of the Dow Jones U.S. Select Aerospace & Defense index.

Primarily, the attraction toward the DFEN ETF is that it offers a convenient mechanism for speculation. Ordinarily, those interested in leverage must participate in the options market. However, many options strategies may feature high complexities. On the flip side, Direxion ETFs are intuitive as the underlying units can be bought and sold much like any other publicly traded security. Therefore, the learning curve is shallow.

Still, traders must be aware of the risks of ultra-leveraged ETFs. First, 3X funds like DFEN are extremely volatile. While the good times are great, the bad times are horrific – volatility cuts both ways. Second, these specialized vehicles are designed for exposure lasting no longer than one day. Holding beyond this recommended period may expose investors to value decay due to the daily compounding effect.

The DFEN ETF: Thanks to the chaotic geopolitical environment, the DFEN ETF has been a strong performer, gaining nearly 64% since the start of the year.

The past month offered rich headlines, driving the 3X defense fund to a return of nearly 23%.
So far, momentum has been strong for the DFEN ETF, which trades above its 20-day exponential moving average (EMA), along with the 50- and 200-day moving averages (DMAs).
Ordinarily, a breather may be called for due to the strong run. However, recent tensions may see a detour from this expected outcome.