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I've skimmed through more than one ETF prospectus trying to find the procedure for clamping losses at the limits of an ETF, and so far, no help. Has anyone found a description of the "clamping" procedure?

For example, if the S&P drops 35% in one day, how will Direxion's BGU (3X Bull ETF) "clamp" the loss to that 90% loss number that shows up in their prospectus? I'm looking for some kind of outline of their plan/procedure.

Page 146 of the Direxion ETF prospectus says:

If the Fund’s benchmark moves more than 33% on a given trading day in a direction adverse to the Fund, you would lose all of your money. Rafferty will attempt to position the Fund’s portfolio to ensure that the Fund does not lose more than 90% of its net asset value on a given day. The cost of such downside protection will be limitations on the Fund’s gains. As a consequence, the Fund’s portfolio may not be responsive to Index gains beyond 30% in a given day. For example, if the Index were to gain 35%, the Fund might be limited to a daily gain of 90% rather than 105%, which is 300% of the Index gain of 35%.

Again, I'm looking for a description of how they expect to hold the loss to 90%. A second, but related question is, does this "clamp procedure" start kicking-in when the S&P drops 10%, or even 5%?

Edit (10/24/2011) =========================

After a little digging, it looks like BGU is currently made-up of about 9% in cash/treasuries, 4% in the Russell 1000 Index, and the rest (87%) in swaps. So, they don't have to react to the market to hold the loss to the "90% value". And, this scheme is always active (assuming they keep similar percentages on a daily basis).

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  • $\begingroup$ Caveat Emptor :) $\endgroup$
    – CQM
    Oct 21, 2011 at 3:17
  • $\begingroup$ I'm not sure how any individual ETF does it, but it's a relatively simple matter in theory to dial down the leverage by buying/selling as the market's daily moves hit certain thresholds, no? It may be a case like portfolio insurance, where actual results underperform the theory due to jumps and lack of liquidity on such volatile days, but considering how rare/unlikely a 30%+ day is, it seems unlikely they have anything beyond vague ideas of how to deal with such a situation. This also does not seem to be a "quantitative" question. $\endgroup$
    – Tal Fishman
    Oct 22, 2011 at 23:45

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It depends a lot on the structure of the ETF, it could be : * In the "terms and conditions" of the (highly possible) total return swap of the fund * Portfolio insurance * Option combination (or cap & floor)

I think it's in the swap details, already saw that a few times.

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