Leveraged ETFs: Is Tracking Error Really So Troublesome?

Judging by trading volume, the ProShares leveraged ETFs have attracted a large following, and so too have rivals, the more noteworthy, thus far, being the triple leveraged ETFs just launched by Direxion. Judging from the financial media, however, these funds have also attracted much, and sometimes shrill, criticism. There are more issues here than can be addressed at one time. I’ve already addressed longer-than-a-day holding periods on several occasions, the most recent of which can be found here. Today, I want to tackle "tracking error," the extent to which an ETF misses the performance target it is supposed to hit.

What if an index fund doesn't match the index

Imagine jumping through all sorts of strategic hoops and ultimately concluding that it's best to track the S&P 500. You buy an ETF that says it will do just that. But after a short time, you notice that your ETF substantially underperformed the S&P 500. That would be a disaster. It's bad enough to underperform when you assume the risks inherent in trying to outperform. How much worse is it when you deliberately forgo the upside opportunity, but wind up underperforming anyway.

"Tracking error" is the phrase used to describe this nightmare scenario. (Strictly speaking, tracking error also results when you inadvertently outperform the benchmark, and theorists jump on this as well.)

Fortunately, in the real world, tracking error on S&P 500 funds tends to be trivial. Transaction costs, other fund expenses, rebalancing protocols, and sometimes a decision to invest only in a sample of an index, all result in some sort of friction. So we can't ever expect tracking error to be zero. But when we're talking about well-established benchmarks, the error tends to be so small, it can be comfortably ignored by the average investor.

Tracking error in leveraged ETFs

Leveraged ETFs, whether long or short, are different. They use derivatives to help them achieve their goals of magnifying the benchmark's gain or loss. This can be considerably less precise than simply purchasing index constituent stocks. Therefore, if you are going to invest in leveraged ETFs, accept the reality of meaningful tracking error.

Critics believe this should end the inquiry. Leveraged ETFs have tracking error: Gotcha!

It's not that simple. If a leveraged ETF, even with noticeable and persistent tracking error, can still deliver in a way that will allow an investor to execute a chosen strategy, and do so more effectively than any available alternative, it would seem that the leveraged ETF remains a valuable tool. That is what will be examined here; whether or not leveraged-ETF tracking error prevents them from delivering what investors can reasonably expect.

A quick tracking-error study

Daily price changes were evaluated for several leveraged ETFs from the start of 2009 through 3/12/09. This includes some seasoned trading patterns for the ProShares offerings, which were released earliest, some less mature trading activity for some slightly newer Rydex offerings, and some early trading patterns for the most-recently launched Direxion ETFs.

Table 1 shows tracking error for ETFs based on the S&P 500. SPY, the most traditional of S&P 500-ETFs is included as a point of reference.

Table 1 - Tracking Error In Leveraged ETFs Based On S&P 500

ETF Ticker	Type of Leverage	Daily % Tracking Error
		Median	Mean	Standard Dev.
SPY	None	-0.01%	0.01%	0.18%
SSO	Double Long	0.00%	-0.02%	0.36%
SDS	Double Short	0.01%	0.04%	0.38%
RSU	Double Long	-0.08%	0.01%	0.47%
RSW	Double Short	0.05%	0.02%	0.54%
BGU	Triple Short	-0.08%	-0.05%	0.65%
BGZ	Triple Long	0.11%	0.10%	0.60%

As expected, tracking error for SPY is miniscule and the propensity for error seems to grow as we move from double leverage to triple leverage.

Tables 2 and 3 show that tracking error grows a bit when we look at leveraged ETFs based on the Russell 2000 and the NASDQ 100. (Actually, it grows even when we compare unleveraged Russell and NASDQ ETFs to SPY.)

Table 2 - Tracking Error In Leveraged ETFs Based On Russell 2000

ETF Ticker	Type of Leverage	Daily % Tracking Error
		Median	Mean	Standard Dev.
IWM	None	0.12%	0.02%	0.37%
UWM	Double Long	0.01%	-0.02%	0.70%
TWM	Double Short	0.21%	0.07%	0.79%
RRY	Double Long	-0.06%	0.02%	1.03%
RRZ	Double Short	0.03%	0.00%	0.93%
TNA	Triple Short	-0.03%	-0.01%	1.22%
TZA	Triple Long	0.20%	0.09%	1.07%

Table 3 - Tracking Error In Leveraged ETFs Based On NASDQ 100

ETF Ticker	Type of Leverage	Daily % Tracking Error
		Median	Mean	Standard Dev.
QQQQ	None	0.16%	0.13%	0.48%
QLD	Double Long	-0.21%	-0.24%	1.10%
QID	Double Short	0.24%	0.27%	1.05%

The question in all cases is whether the tracking error we see should scare us away from leveraged ETFs.

If you look anecdotally at a smaller number of days, you will undoubtedly see instances of tracking error that are much larger than anything presented in the above tables, which reflect aggregate figures based on about ten weeks. Individual days will be larger, but there seems to be no systematic bias as to whether the error is positive or negative. As a result, the positive and negative errors largely cancel one another out in less than a quarter.

We'll also consider the absolute extent of tracking error, i.e. without allowing the ups and downs to offset one another. But before doing that, let's see how average tracking error looks for single-sector leveraged ETFs.

In the latter case, measuring tracking error may not always be so straightforward, since the ETFs are designed to track custom indexes often created specifically for use with that ETF. For this study, however, iShares offers some convenient sector benchmarks. For one thing, it's a major ETF brand and for many, the search for sector ETFs begins and ends with iShares. Better still, proprietary sector indexes tracked by the iShares ETFs (produced by Dow Jones) are the same ones used by ProShares. Rydex and Direxion use sector indexes created by other vendors (S&P and Russell respectively). Nevertheless, I benchmarked to iShares ETFs across the board.

Tables 4 through 8 show aggregate early-2009 tracking error for a sampling of sectors.

Table 4 - Tracking Error In Leveraged Real Estate ETFs (unofficial benchmark = IYR)

ETF Ticker	Type of Leverage	Daily % Tracking Error
		Median	Mean	Standard Dev.
URE	Double Long	-0.01%	0.09%	1.11%
SRS	Double Short	0.01%	0.12%	0.92%

Table 5 - Tracking Error In Leveraged Energy ETFs (unofficial benchmark = IYE)

ETF Ticker	Type of Leverage	Daily % Tracking Error
		Median	Mean	Standard Dev.
DIG	Double Long	0.16%	0.03%	0.58%
DUG	Double Short	0.03%	0.01%	0.58%
ERX	Triple Short	0.24%	0.07%	0.79%
ERY	Triple Long	0.05%	-0.02%	0.91%

Table 6 - Tracking Error In Leveraged Financial ETFs (unofficial benchmark = IYF)

ETF Ticker	Type of Leverage	Daily % Tracking Error
		Median	Mean	Standard Dev.
UYG	Double Long	-0.04%	0.00%	1.05%
SKF	Double Short	0.01%	0.08%	0.76%
FAS	Triple Short	0.11%	0.05%	1.64%
FAZ	Triple Long	0.33%	0.35%	1.35%

Table 7 - Tracking Error In Leveraged Healthcare ETFs (unofficial benchmark = IYH)

ETF Ticker	Type of Leverage	Daily % Tracking Error
		Median	Mean	Standard Dev.
RXL	Double Long	0.14%	0.00%	0.50%
RXD	Double Short	0.04%	0.01%	1.00%

Table 8 - Tracking Error In Leveraged Technology ETFs (unofficial benchmark = IYW)

ETF Ticker	Type of Leverage	Daily % Tracking Error
		Median	Mean	Standard Dev.
ROM	Double Long	-0.02%	0.02%	0.52%
REW	Double Short	0.10%	0.04%	0.46%
TYH	Triple Short	-0.04%	0.07%	0.66%
TYP	Triple Long	0.15%	0.03%	0.81%

We see above that the sector ETFs were imperfect. Deviations exceeded what we saw for leveraged ETFs based on major indexes. As to whether the imperfection is excessive, that's a matter of individual opinion. Speaking for myself, though, I do not believe these levels of tracking error will interfere with the sort of strategic goals that would cause one to invest in leveraged ETFs.

Tables 9 through 16 look at all the foregoing leveraged ETFs but this time, the focus is on "absolute value." In other words if the market moves 2%, and the ETF moves 2.5%, we would say tracking error is 0.5%, We'd say the same if the ETF moves 1.5%. This way, we can test how effective leveraged ETFs are at magnifying the daily moves without giving them an opportunity to offset positive and negative errors.

The first data column in each of the following tables looks at what happened in the market, the absolute size of the average daily benchmark move. The second data column applies the doubling or tripling, depending on what the ETF is supposed to offer. This is what a zero-tracking-error ETF would deliver. The final column shows what the real world ETF actually wound up delivering.

In other words, if the absolute value of a benchmark's average daily price change is 1.5% (first numeric column), investors would expect a two-times leveraged ETF to produce an absolute daily average change (second column) of 3%. An ETF that actually achieves an absolute daily average (third column) of 1.8% would not be considered a success. Its use of derivatives did not properly deliver on the 3% target. But if the ETF's daily average absolute price change (third column) is 2.9%, we'd acknowledge the presence of tracking error, but most observers would still say the ETF did a magnificent job in executing on its goals.

(Methodology note: There is a potential trap in using absolute value: the crossing zero issue. Consider the situation with SDS, the S&P 500 ultra short ETF, on 1/5/09. The index dropped 0.47 percent, thus making for a plus 0.93% ultra short target. SDS, nevertheless, dropped 0.09%. If I were to apply absolute value to 0.93% and -0.09%, we'd wind up with 0.93% and 0.09%, and, hence, a tracking error of 0.84%. That's not correct. I compute the tracking error first, which in this case is -1.02%, and then apply absolute value to get 1.02%.)

Table 9 - Impact Of Leverage, ETFs Based On S&P 500

ETF Ticker	Type of Leverage	Absolute Values of daily % changes
		What happened in the market	The result one had hoped to achieve using leverage	What the leveraged ETF actually delivered
SSO	Double Long	1.55%	3.09%	2.89%
SDS	Double Short	1.55%	3.09%	2.86%
RSU	Double Long	1.55%	3.09%	2.80%
RSW	Double Short	1.55%	3.09%	2.73%
BGU	Triple Short	1.55%	4.64%	4.21%
BGZ	Triple Long	1.55%	4.64%	4.22%

Table 10 - Impact Of Leverage, ETFs Based On Russell 2000

ETF Ticker	Type of Leverage	Absolute Values of daily % changes
		What happened in the market	The result one had hoped to achieve using leverage	What the leveraged ETF actually delivered
UWM	Double Long	2.00%	4.00%	3.41%
TWM	Double Short	2.00%	4.00%	3.44%
RRY	Double Long	2.00%	4.00%	3.40%
RRZ	Double Short	2.00%	4.00%	3.31%
TNA	Triple Short	2.00%	6.00%	5.14%
TZA	Triple Long	2.00%	6.00%	5.17%

Table 11 - Impact Of Leverage, ETFs Based On NASDQ 100

ETF Ticker	Type of Leverage	Absolute Values of daily % changes
		What happened in the market	The result one had hoped to achieve using leverage	What the leveraged ETF actually delivered
QLD	Double Long	1.83%	3.66%	2.97%
QID	Double Short	1.83%	3.66%	2.88%

Table 12 - Impact Of Leverage, Real Estate ETFs

ETF Ticker	Type of Leverage	Absolute Values of daily % changes
		What happened in the market	The result one had hoped to achieve using leverage	What the leveraged ETF actually delivered
URE	Double Long	3.28%	6.56%	5.81%
SRS	Double Short	3.28%	6.56%	5.96%

Table 13 - Impact Of Leverage, Energy ETFs

ETF Ticker	Type of Leverage	Absolute Values of daily % changes
		What happened in the market	The result one had hoped to achieve using leverage	What the leveraged ETF actually delivered
DIG	Double Long	1.98%	3.97%	3.56%
DUG	Double Short	1.98%	3.97%	3.56%
ERX	Triple Short	1.98%	5.95%	5.49%
ERY	Triple Long	1.98%	5.95%	5.15%

Table 14 - Impact Of Leverage, Financial ETFs

ETF Ticker	Type of Leverage	Absolute Values of daily % changes
		What happened in the market	The result one had hoped to achieve using leverage	What the leveraged ETF actually delivered
UYG	Double Long	3.02%	6.04%	5.42%
SKF	Double Short	3.02%	6.04%	5.75%
FAS	Triple Short	3.02%	9.05%	8.13%
FAZ	Triple Long	3.02%	9.05%	8.37%

Table 15 - Impact Of Leverage, Healthcare ETFs

ETF Ticker	Type of Leverage	Absolute Values of daily % changes
		What happened in the market	The result one had hoped to achieve using leverage	What the leveraged ETF actually delivered
RXL	Double Long	1.14%	2.28%	3.32%
RXD	Double Short	1.14%	2.28%	1.92%

Table 16 - Impact Of Leverage, Technology ETFs

ETF Ticker	Type of Leverage	Absolute Values of daily % changes
		What happened in the market	The result one had hoped to achieve using leverage	What the leveraged ETF actually delivered
ROM	Double Long	2.03%	4.06%	3.79%
REW	Double Short	2.03%	4.06%	3.74%
TYH	Triple Short	2.03%	6.09%	5.68%
TYP	Triple Long	2.03%	6.09%	5.63%

As with Tables 1 through 8, reasonableness is in the eye of the beholder. But in my opinion, all the tracking error we see here is acceptable. Take, for example, SKF, the ProShares Ultra Short Financial ETF. Had I owned it in early 2009, I'd have hoped to see absolute average daily price movements of 6.04%, double that of the relevant Dow Jones sector index. But I only got 5.75%.

From the vantage point of a theorist, that gap is big enough to mention when discussing whether or not leveraged ETFs have meaningful tracking error. But from the standpoint of an investor, should that make me abandon an intent to double short the financials? In assessing whether or not magnifying 3.02% into 5.75% is a reasonable outcome for one who had hoped to magnify 3.02% into 6.04%, consider that alternatives. What sort of risks or impracticalities are associated with other methods of implementing an aggressive-bear strategy in finance?

I find it particularly noteworthy that tracking error on the triple leverage funds seems in line. Remember, those funds work with Russell benchmarks. Apparently, the differences between those and the Dow Jones indexes are not great, a separate topic that should be of interest when one is considering sector ETFs in general.

Conclusion

Yes, leveraged ETFs feature significantly more tracking error than ETF traditionalists are accustomed to accepting, and if we're playing "Gotcha," the traditionalists win big. But were not playing "Gotcha." We're looking to implement a variety of interesting investment strategies. In this regard, the ETFs examined here delivered quite nicely during the course of this early-2009 sample period.

It would not be appropriate for me to generalize from this to the point of saying we can disregard all tracking error for all leveraged ETFs. But I think the data is sufficient to say that if one is concerned about tracking error, it would be best to specifically study, case-by-case, the ETFs one is considering. To use tracking error as a basis for dismissing leveraged ETFs in general seems incorrect.

Comments

[WorkerOnWal...:]

And don't forget... "Tracking Error" always seems to occur in favor of the outfits running the funds. You buy a 3x bull fund, and it goes up less than 3x when the index goes up by x. But when you buy a 3x bear fund and the index goes down by x, you find the ETF will go down by more than 3x.

Buyer beware. Madoff's buddies still run Wall Street.

Mar 19 06:19 AM

[2houndz:]

Whatever. There's at least 9,000 equity vehicles from which to choose. If this is so bothersome, then focus on something else. The ultras and triples are fantastic tools for those who have figured them out.
Here's a tip: If you consider yourself an investor instead of a trader, then stay away from these things.

Mar 19 08:19 AM

[Atsui:]

Maybe I'm missing something here about tracking error.

My experience is that I make money trading leveraged ETF regardless of whether the tracking error is large or small.

Mar 19 08:39 AM

[User 352668:]

Yes! And in addition, I even make money as a mere retail trader holding the USO and DXO for days/weeks in spite of all the dire warnings of contango...


On Mar 19 08:39 AM User 359032 wrote:

> Maybe I'm missing something here about tracking error.
>
> My experience is that I make money trading leveraged ETF regardless
> of whether the tracking error is large or small.

Mar 19 09:11 AM

[cvhaus:]

I think the naysayers on leveraged ETF's don't see the bigger picture. I've seen written MANY times that leveraged ETF's are NOT for long term investors. What these people fail to tell tell you, or be a proponent of, is a theoretical ETF that would equal HALF the daily % move of a given index. Would this theoretical ETF be more safe than the underlying index? Would it be a BETTER long term investment? I'll leave that for others to debate, but I suspect no one will create such a product because it's HOOEY that it would perform better than the underlying index over a typical long term market cycle (I'm talking 10 years of more in a typical market that is returning 10% per year). In this case, the INDEX itself would be 2X the move of this theorectical underlying security, and would exhibit similar characteristics as a 2X index fund, relatively speaking. Over the extreme long term, and when someone is expecting to be adding money to the original position in a market downturn, leveraged ETF's can indeed be a great longer term investment in a typcial long term market cycle, IMHO. Yes beta is much higher, but if long term alpha is also higher- I'm cool with that... I'd rather take on market/sector risk with high beta than individual stock selection risk, where all that separates you from alot of lost dough is a liar at the company or an analyst with a conflict of interest... It's much harder to manipulate an entire sector or market...

Mar 19 10:43 AM

[Wrenchmensch:]

Correction:

In the above article, the table on financial ETFs has FAS and FAZ transposed. FAS is Direxion's triple long, and FAZ is Direxion's triple short.

"To err is human"

Mar 19 11:40 AM

[Alan Young:]

I don't believe I've seen complaints about DAILY tracking error--the rather narrow scope of this study. Instead, people tend to be surprised by the daily re-calibration of the funds, leading to very large "tracking error" over a longer time span. That's a flaw in the investment thesis or technique, not a flaw in the construction or operation of the ETFs. But it still has to be kept in the forefront of any discussion about how to use leverage.

Mar 19 12:41 PM

[Mad Hedge F...:]

Nice work. This could be the year of the Exchange Traded Fund (ETF), which was one of the few growth products in an otherwise disastrous year for the brokerage community. Asset allocators are attracted by the ability to make single sector bets, like in oil (USO), leveraged short plays that would otherwise be banned, like the 200% short long Treasuries fund (TBT), intraday trading, and low fees. The only thing missing is liquidity, which is still inadequate in all but a few of the biggest ETF’s. There is now thought to be $400-$500 billion invested in these funds, compared to $4 trillion plus in mutual funds, and the rate of innovation is accelerating. The early entrants in the field, like Vanguard and Barclays Bank, are raking in the cash, leaving more conservative families of funds like Fidelity in the dust. Expect to start seeing more ETF’s in your 401K’s and pension holdings.

Mar 19 02:10 PM

[AndrewBaker:]

I agree that in a less volatile market but one trending in the "right" direction, a longer holding period can be beneficial. The real risk is in a volatile market especially if a big swing against you occurs right after buying which stops you from selling and maybe buying the inverse offering. I have sold out early at a noticeable loss when on occasion the trend moved agailst me, bought the inverse and sold that early when a small profit arose. In several cases I could have stayed with the original direction - which, after all, must have indicated itself to me for me to buy in the first place - and would have profited a little further along the line once the initial wrong move had reversed itself and the price then in time went back up through my buying cost. This happens often when anticipating a move, but getting in too early, and I am looking for ways to deal with this. The VIX is one way that seems like it may help: go long on low VIX levels (say, under 41 or 42), and short above that. We're all still learning how best to trade.

Mar 19 02:41 PM

[lavalyn:]

WorkerOnWallStreet and cvhaus: interesting points about the tracking errors and the theoretical 0.5x index tracker.

You'd actually expect the 0.5x tracker to consistently slightly outperform half the index, on "interest" for the other half. Similarly, a 2x tracker should consistently slightly underperform on "interest."

Mar 19 03:54 PM

[Chris B:]

I would suggest that much of the source of these tracking errors is in the difference between the people who trade ETF's and the people/institutions who trade the entire index as individual shares/contracts.

If you are JPMorgan managing multi-million dollar positions, you have no incentive to accept any portion of the fund's annual expenses of 0.1% or so. Your cost to trade the actual index is lower than that, so you avoid the ETF and invest directly.

On the other hand, if you are a "small" investor, buying or selling 40 or so orders one at a time might cost you 40 * $10 commission * 2 one buy and one sell = $800. If you are "only" trading a position of a quarter-million dollars or so, the ETF's 0.1% expenses for the year amount to just $250 and your comission amounts to $20 for one buy and one sell. Net savings from using the ETF instead of re-creating it: $540 and a lot of trading effort. These savings would magnify the more often you trade into and out of an index in a year.

So indexes and ETF's have different customers. It's a different market, with slightly different prices. If small investors are bullish, ETF's go up faster than the index. If large investors are bullish, the index outperforms the ETF.

Mar 19 05:00 PM

[bcncv:]

Thank you for the numerical analysis, although I must admit it goes against my personal experience in trading these.

I first tried holding a few of these for several months, and they generally moved as they were supposed to over a several day period. However, over a several month period, the actually went the opposite the direction they were supposed to.

I'd be curious to see a similar analysis by overlaying charts from different time periods. A picture can tell a story that thousands of words cannot.

Mar 19 05:53 PM

[MinAkkar20:]

I feel the critics of ETFs are people who feel threatened by their existence (ie competitors like active managers and mutual funds). The point of this article is correct - although the exact leverage might be off a bit, the fund offers what it advertises: a greater than 1to1 movement with (or inverse of) the index. Whether it's 1.5, 1.75 or 2 is just a matter of metrics.

Mad Hedge Fund Trader is correct - those who neglect to develop these products are missing the bus. And besides, leveraged ETFs aren't great long term investments compared to what? Large Cap Mutual Funds? ha

Mar 19 06:12 PM

[Alan Young:]

To BCNV: Your observation is typical.

Here's an example: SRS is -2x the same index as IYR on a daily basis
If you bought IYR at the exact bottom on Nov. 21, the price was 22.92; the most recent low on March 6, was 20.98, down 9%,
If you bought SRS at the same time, you paid 273.48; on March 6, rather than being +18% as you would like, it was DOWN 60% at 111.22 !

As Mr. Gerstein goes to such pains to demonstrate, the tracking error on a daily basis is trivial. That wasn't the problem to begin with, so the whole article is something of a straw-man critique.

As I posted earlier, people tend to be surprised by the daily re-calibration of the funds, leading to very large "tracking error" over a longer time span. That's a flaw in the investment thesis or technique, not a flaw in the construction or operation of the ETFs. But it still has to be kept in the forefront of any discussion about how to use leverage.

Mar 20 12:41 AM

[sr9web:]

Let's not forget that short ETFs such as DXD, SDS and FXP allow IRA holders to go short, which they can;t do with individual stocks... very important point!

Mar 20 02:16 AM

[deepvalue:]

I've got two words for all of you: path dependency.

Daily tracking error is not the issue. Over longer periods, path dependency is what creates massive tracking error. In volatile markets you will not get the 2x index result you were expecting.

It's a compounding situation.

Mar 20 09:37 AM

[Fish Gone Bad:]

Direxion has 16 triple leveraged ETFs:
3X Bull:
ERX - DIREXION SHS ETF TR ENERGY BULL 3X
FAS - DIREXION SHS ETF TR FINL BULL 3X
BGU - DIREXION SHS ETF TR LARGE CAP BULL
TNA - DIREXION SHS ETF TR SM CAP BULL 3X
...
3x Bear:
ERY - DIREXION SHS ETF TR ENERGY BEAR 3X
FAZ - DIREXION SHS ETF TR FINL BEAR 3X
BGZ - DIREXION SHS ETF TR LARGE CAP BEAR
TZA - DIREXION SHS ETF TR SM CAP BEAR 3X
...
You got the bull/bear turned around. You can find descriptions here: www.direxionfunds.com

Mar 20 09:51 PM

[squark62:]

well marc, you sure stirred up hornets nest. as i've pointed out many times, pairing up long & short ETFs that specifically follow the same index (directly or inversely) is an excellent what to establish a hedge. the hedge can be correlated, non-correlated or neutral. it's up to the trader. weighted properly, using this type of method of hedging you effectively create your own asset class. this enables investors who manage their own ira to hedge since options trading is not allowed in retirement accounts, but holding these ETFs are. interested? checkout www.equityinformatics.com

Mar 21 01:24 PM

[donzelion:]

A slight daily tracking error is no problem at all - for day traders. A slight daily tracking error that compounds daily is a serious problem for anyone whose strategy involves a longer time horizon.

Mar 22 03:49 AM

[the_lazy_ob...:]

Since the downside cannot go more than 100%, while the upside can exceed 100%, if you buy both long and short of the ETFs that follow the same index (ex.: FAS and FAZ), you'd either end up even (minus a small commission) or in profit. That's on a daily basis, since these reset daily. The net should be small but if you do it often enough, it should be profitable in the long run.

Mar 25 11:10 AM

[aarc:]

xETF has price compounding effect that theoretically favors the bulls rather than the bears.

Make a simple straight line computation of the compounding effect of xETF.

I have an example: Starting price of $10 and 10% rally everyday for 5 days.

Day 1 $10.00
Day 2 1xETF = $11 2xETF = $12
Day 3 1xETF = $12.10 2xETF = $14.40
Day 4 1xETF = $13.31 2xETF = $17.28
Day 5 1xETF = $14.64 2xETF = $20.736

Total Profit 1xETF = $4.64 2xETF = $10.73

2xETF performance over 1xETF = 231%.

Do your own calculation to the downside: My calculation yielded a 2xETF 172% yield over 1xETF. Meaning, profit potential to the downside is not as good as the upside with the 2xETF price compounding effect.

Lets look at the XLF and UYG:

During the last downturn and the most recent upturn using peak to trough and trough to peak resply:

XLF went down from 10.09 early Feb to 5.88 early March for a 41.7% percent profit for shorts in 19 trading days. It went up from 5.88 early March to 9.90 mid March for a 40.6% profit for longs in 10 trading days.

UYG using the same 19 days down and 10 days up yielded a profit for shorts of 63.80% and a profit for longs of 127.7%.

To the downside; UYG performed 152.8% over XLF.

To the upside; UYG made 314.6% over that of XLF. Performing like a 3x in percentage basis.

Boy - that is the effect of price compounding to the upside! Remember, when you deposit $10,000 into the bank and don't withdraw the interest profit everyday, that profit will earn interest the next day - and so on and so forth. $10,000 will double in 16 years with 5% interest compounded yearly. While without compounding, it will require 20 years to double.

FAS which is a 3xETF of XLF made 581% price appreciation over XLF during the same 10 days rally in March 2009.

Do your math.

Apr 07 12:44 PM

[User 305589:]

nice work on daily tracking errors - but it completely misses the big picture. let's take FAZ/FAS as an example. If you had bought both of them one year ago you should expect that one would be up and the other one down or both little changed, no? Wrong.
FAZ is down a whopping 93% - and FAS is up, wait, it is down, too, though 'only' by 35%.
Go figure. You can talk about daily tracking errors as long as you want. At the end of the day the leveraged ETFs are for daytrading or a few days holding periods only or else they will ruin you, no matter what the market does.

finance.yahoo.com/echa...;range=1y;compare=faz;...

Apr 23 06:20 AM

[User 305589:]

sorry, but this is nonsense. you will lose money big time the longer you hold xETFs. For instance, over the past 12 months, if you had bought FAS and FAZ which are supposed to be just inverse on a daily basis (one 3x bull, one 3x bear) you would have lost 93% on the one and another 35% on the other. Free money for the creators of the ETF. a huge empty bag for the buyers and holders of this crap.


On Mar 21 01:24 PM squark62 wrote:

> well marc, you sure stirred up hornets nest. as i've pointed out
> many times, pairing up long & short ETFs that specifically follow
> the same index (directly or inversely) is an excellent what to establish
> a hedge. the hedge can be correlated, non-correlated or neutral.
> it's up to the trader. weighted properly, using this type of method
> of hedging you effectively create your own asset class. this enables
> investors who manage their own ira to hedge since options trading
> is not allowed in retirement accounts, but holding these ETFs are.
> interested? checkout www.equityinformatics.com

Apr 23 10:27 AM

[Marc Gerstein:]

12 months....wow!!!!!!!! I'm sorry but when I glanced at that, I didn't even bother to read the rest of the comment. If someone does that and gets burned, who cares. It's the equivalent of someone deliberately chopping off his own hand and then trying to blame the axe manufacturer. It's absolutely and completely unreasonable to even discuss holding these day-oriented leveraged ETFs for a year.

Check my subsequent study: seekingalpha.com/artic...

We all know (or at least are supposed to know) that one day is the proper holding period if one wishes these ETFs to perform as per the label (double or triple). We also know that investors cheat ... they hold longer than a day. That study looks at how long one might hold before making a total mess of his/her portfolio. Based on that data, it seems to me that even 60 trading days is probably too long. I tend to build models based on 20 days and have been getting good results. Others may disagree and prefer shorter limits.

But a year . . . please . . . spare me. I don't have the patience to argue that one ought not use an axe to chop off one's own hand and i don;t have the patience to argue that one ought not hold a day-oriented leveraged ETF for a year.



On Apr 23 10:27 AM User 305589 wrote:

> sorry, but this is nonsense. you will lose money big time the longer
> you hold xETFs. For instance, over the past 12 months, if you had
> bought FAS and FAZ which are supposed to be just inverse on a daily
> basis (one 3x bull, one 3x bear) you would have lost 93% on the one
> and another 35% on the other. Free money for the creators of the
> ETF. a huge empty bag for the buyers and holders of this crap.<br/>

Apr 23 01:20 PM