More Fun with Levered ETFs 21 comments
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Lately I find myself repeatedly explaining how levered ETFs work, so I thought I would help myself out by putting up a table that gets the point across empirically. The gist: Such products reset on a daily basis, so you are really levering up only on a single-day’s numbers, not on a multi-day trend. The difference can be highly significant, as this table shows.
Note: I’m not saying the following is bad. It’s just something you need to be sure you know when trading levered ETFs. They don’t always act the way you might naively think they do.
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This article has 21 comments:
Any idea how these levered ETFs execute their trades. Do they accumulate trades until late in the day and then execute? Any thoughts/ theories into if levered ETFs add to late day sell-offs?
Because if not, doesn't that mean I could make a riskless profit by simultaneously shorting both the levered and inverse levered funds?
Day 1 +5%: 1x -105, 2x -110, -2X 90
Day 2 +7%: 1x - 112.35, 2X - 125.4, -2X - 83.70
Day 3 +3%: 1X - 115.72, 2X - 132.94, -2X - 78.68
It's just math. If you shorted both, you would be out 11.6% of the nominal amount of your investment. The same thing would work in a downward trending market. As Paul, who seems to be a little slow on the uptake regarding how volatility and leverage work, properly notes, these things are dogs when the market moves around a lot and ends up right where it started.
On Dec 12 08:17 PM Hmmmm... wrote:
> In your example, you would have lost money holding either the levered
> or the inverse levered ETFs, which seems crazy. I assume there must
> be situations where bother the levered and inverse levered would
> MAKE money?
>
> Because if not, doesn't that mean I could make a riskless profit
> by simultaneously shorting both the levered and inverse levered funds?
DXO, introduced a few months ago.
And Alan, don't denigrate Paul's numbers. The fact that the market continues to move around a lot makes your entire counterpoint meaningless. And why is it moving around a lot? Because institutions, funds, and traders are using TOO MUCH LEVERAGE. You are either in the market or out. If you want to do side bets, Vegas has plenty of football prop bets that you can hedge or lever yourself into a hole without disrupting the market through levered volatility.
On Dec 13 08:24 AM Alan Brochstein wrote:
> The reason both lose money is that they were "whipsawed". The market
> moved around a lot, but ended up roughly unchanged. Allow me to
> tell you how you will have your ass handed to you if you simply short
> them both (without rebalancing):
>
> Day 1 +5%: 1x -105, 2x -110, -2X 90
> Day 2 +7%: 1x - 112.35, 2X - 125.4, -2X - 83.70
> Day 3 +3%: 1X - 115.72, 2X - 132.94, -2X - 78.68
>
> It's just math. If you shorted both, you would be out 11.6% of the
> nominal amount of your investment. The same thing would work in
> a downward trending market. As Paul, who seems to be a little slow
> on the uptake regarding how volatility and leverage work, properly
> notes, these things are dogs when the market moves around a lot and
> ends up right where it started.
>
>
>
>
>
> On Dec 12 08:17 PM Hmmmm... wrote:
I am not a trader, the only games I like to play are single person shoot em ups or RPGs.
As far as I'm concerned, the only reason I mentioned DXO is that its down 90% and oil will be much higher by the time it becomes a long term investment. 12 month holding period. I'm treating it as a stock.
You are the Pros on these type of investments, I was hoping to get some feedback.
Thanks
DXO..as you obviously didn't learn from the preceding garbage is a Powershares Double Long Oil ETN..access it thru etfconnect.com..with the OPEC meeing coming this week..and production prices below sell prices DXO makes sense..
But..and here's the rub..these investments need to vetted..do your your due diligence..don't accept some self-promoters (paultaut) off hand comment.......
Examples:
12/10/08, Financials, one day: XLF (financials 1x index) is down 0.99%. You would expect UYG (ultra-long) to be up 1.98% and SKF (ultra-short) to be down 1.98%. Instead, UYG is DOWN 0.80% and SKF is UP 0.18%, exactly the opposite direction and no relationship in magnitude.
12/12/08, Real Estate, one day: URE (ultra-long) is up 7.53%, SRS (ultra-short) is down 19.21%.
12/13/08, S&P 500, one month: SPY (1x index) is up 4%; SSO (2x long) is up half as much, 2%; SDS (2x short) is down 17%.
Look at the charts and the situation will be very obvious. And very bad.
So all of the previous posts are " Preceding Garbage", too bad, I thought they were informative. IMO
Please tell me why I should stop learning how markets function? Ah, but you already know everything about everything, so why do you bother viewing any Article?
IMO
I provided my example as an illustration. When the market is very volatile but not trending, these things BLOW. When the market is trending sharply, one BLOWS and the opposite one ROCKS. To speak negatively of the instrument shows a lack of understanding. It does what it is supposed to do. I know you aren't an investment pro, but it would be similar to criticizing a strategy of selling covered calls (buy a stock and sell calls against it to collect "income") before a huge rally. Of course, if one KNOWS that the market will be very volatile but end up unchanged over a time-frame, then these leveraged ETFs are "bad". If you link back to Paul's original efforts in this area, you will see that he was himself "naive" about the way they worked. He could have better illustrated his point in this market by doing a more complete job and laying out additional scenarios.
As far as your point about doing this or doing that, I wasn't suggesting that you or anyone do anything but to understand the way these securities work. Allow me to share a real world example with you.
Assume you have a long-term investment portfolio with short-term capital gains (not likely these days!). In this example, while you fear the market could drop a lot over the next month, you would like to minimize the sale of securities so that they can roll into long-term for favorable taxation. By using a leveraged ETF (double negative), you could minimize your sells. There are other strategies, including margin and short sales, options etc.
Realistically, though, these leveraged ETFs allow traders to place relatively large bets in the very short-term. You can criticize the actions of traders, which is fine, but it isn't fair to criticize the security itself (as many are doing).
On Dec 13 12:49 PM Jimmy Lathrop wrote:
> Let me get this straight, Alan, because I am just a dumb dirt attorney
> from Brooklyn. Instead of just holding a security, and paying a fee
> or transaction cost to purchase it, I also need to short the security,
> either by buying an option with another transaction fee, or purchase
> a levered fund, which has a transaction fee and a management fee.
> All I see are lots of transaction fees which come out of my initial
> investment, high volatility and unnecessary complication when all
> you need to do is either be long or be out. Your solution sounds
> good if you are collecting the management fee or if you are being
> paid to tout these redundant products. Southwest Airlines came out
> ahead with their hedging strategy in jet fuel in the earlier part
> of the year, now they are getting punished because they are holding
> contracts when they could buy it on the spot market for cheaper.
> Abraxas Petroleum has an enormous hole in their balance sheet with
> their hedging contracts which has completely destroyed shareholder
> value. And finally, if you can't trust Madoff, how can you be completely
> sure that the counterparties in these levered ETFs are going to pay
> out when you try to sell them?
>
> And Alan, don't denigrate Paul's numbers. The fact that the market
> continues to move around a lot makes your entire counterpoint meaningless.
> And why is it moving around a lot? Because institutions, funds, and
> traders are using TOO MUCH LEVERAGE. You are either in the market
> or out. If you want to do side bets, Vegas has plenty of football
> prop bets that you can hedge or lever yourself into a hole without
> disrupting the market through levered volatility.
I don't recommend the use of these securities to anyone but traders or people who are restricted for whatever reason from shorting or options.
On Dec 13 12:49 PM Jimmy Lathrop wrote:
> Let me get this straight, Alan, because I am just a dumb dirt attorney
> from Brooklyn. Instead of just holding a security, and paying a fee
> or transaction cost to purchase it, I also need to short the security,
> either by buying an option with another transaction fee, or purchase
> a levered fund, which has a transaction fee and a management fee.
> All I see are lots of transaction fees which come out of my initial
> investment, high volatility and unnecessary complication when all
> you need to do is either be long or be out. Your solution sounds
> good if you are collecting the management fee or if you are being
> paid to tout these redundant products. Southwest Airlines came out
> ahead with their hedging strategy in jet fuel in the earlier part
> of the year, now they are getting punished because they are holding
> contracts when they could buy it on the spot market for cheaper.
> Abraxas Petroleum has an enormous hole in their balance sheet with
> their hedging contracts which has completely destroyed shareholder
> value. And finally, if you can't trust Madoff, how can you be completely
> sure that the counterparties in these levered ETFs are going to pay
> out when you try to sell them?
>
> And Alan, don't denigrate Paul's numbers. The fact that the market
> continues to move around a lot makes your entire counterpoint meaningless.
> And why is it moving around a lot? Because institutions, funds, and
> traders are using TOO MUCH LEVERAGE. You are either in the market
> or out. If you want to do side bets, Vegas has plenty of football
> prop bets that you can hedge or lever yourself into a hole without
> disrupting the market through levered volatility.
For example, NO leverage:
Long 1 share of ABC stock @ $100:
$100. earns 5% = $105. Then loses 5% the next day = $99.75
Short 1 share of ABC stock @ $100
$100 loses 5% = $95. Then gains 5% the next day = $99.75
It's misleading because he's using %'s and not actual dollar amounts.
Leverage, like any other high powered tool, can do very good or very bad things for you. Spend as much time on your exit strategy as your entry point. Good luck.
For example, SRS closing at 77.25 on 12/12 vs. 79.6 on 9/22 = down 3%. I don't know what the value change for the Dow Jones US Real Estate index, which is the underlying index for SRS is for this period (can someone tell me where to find this?) for this period but for the same time frame the S+P 500 is down 27%. Seems pretty clear this double inverse ETF is something can't trust or measure in any meaningful way, and it makes you wonder if there is intentional manipulation of the ETF's value to make it look attractive vs. recent history.
What I am getting from this experience is that the leveraged ETFs are only to be held for a very short time, perhaps no longer than a day, and only used when you have a very strong conviction about the short term direction.
On Dec 13 09:03 PM Kunst wrote:
> Watch out for the ProShares ultra and ultrashort (+/- 2x) ETFs.
> They do not do what they claim, even on a day-to-day basis. The
> longer you hold them, the more inherent downward bias their prices
> have, for both directions.
>
> Examples:
>
> 12/10/08, Financials, one day: XLF (financials 1x index) is down
> 0.99%. You would expect UYG (ultra-long) to be up 1.98% and SKF
> (ultra-short) to be down 1.98%. Instead, UYG is DOWN 0.80% and SKF
> is UP 0.18%, exactly the opposite direction and no relationship in
> magnitude.
>
> 12/12/08, Real Estate, one day: URE (ultra-long) is up 7.53%, SRS
> (ultra-short) is down 19.21%.
>
> 12/13/08, S&P 500, one month: SPY (1x index) is up 4%; SSO (2x
> long) is up half as much, 2%; SDS (2x short) is down 17%.
>
> Look at the charts and the situation will be very obvious. And very
> bad.