Reverse Split Some of the Direxion 3x ETFs?

By now, the behavior of levered ETFs has been very widely document, commented and studied. A common property of the levered ETFs is that they will tend to lose money over time due to a drag on the volatilty. Specifically, if the arithmetic returns (e.g. daily) is ra, and the volatility is v, then the longer term realized geometric returns (e.g. monthly, quarterly etc) rg will be governed by rg = ra – ½ v². Hence, leverage products with higher volatility underlyings will bleed a lot more than leverage products on lower volatility underlyings.

To see some examples of this effect, consider the Since-Inception returns (from the Direxion website) as of April 20th 2009 of a few of the more volatile products:

In the table above, both the Bull and the Bear 3x products are down since inception (SI). It is quite likely that this will also be the eventual fate of their other products as well.

In the long run, it is not difficult to imagine that, if not all, the Direxion products will trade in pennies. Unless, timely reverse splits are carried out.

All of us appreciate the nature and popularity of these products as trading instruments. However, many traders (e.g. myself) operate in environments where they may be mandated to trade instruments that have a price above certain limits such as $5. In addition, if the price is above a certain level, it is possible that shorting might be easier. Additionally, the option market makers might be able to give finer spreads because it is easier to give finer spreads on an underlying trading at $10, than if the underlying is trading at $1 (because of lot size of 100 and other considerations etc).

Disclosure: Not currently holding any Direxion ETFs.

Comments

[kidecar:]

Question: Why would the EFTs eventually trade in the pennies if the underlying stocks continue to grow in PPS? Use FAS as an example.

Jun 03 08:34 AM

[Ron Rowland:]

Uday, I agree. Many of these leveraged ETFs will need to be reverse-split soon.

One of the ETF sponsors (I can't remember who) has pre-defined levels in the prospectus as to when they will perform splits and reverse-splits. (Something like <$10 will trigger reverse-split and o>$200 will trigger split). I just took a quick peek at the prospectus documents for both ProShares and Direxion and they are not the ones, although they both have a provision to reverse-split at the discretion of the board.

Jun 03 12:43 PM

[kkerr:]

The bulls are not guaranteed to go to 0, provided there is enough upward trend to offset the losses due to volatility. This is shown in a chart in this leveraged decay analysis:

blog.quantumfading.com.../

Jun 03 12:53 PM

[AndrewBaker:]

Funny how so many who trade money either for a living or personal investment do not have sufficient math knowledge and skills to work out for themselves how multiple leveraged ETF actually work.

Anything leveraged on a daily basis will lose over time if the upward movements are not always greater than the downward, and that is without charges, which make matters worse. You are in a casino with these instruments, and should remember that over time the house always wins because the odds are stacked, albeit ever-so-slightly, in their favour. And even with craps, where a great player has the odds on their side, almost nobody can keep it up forever.

I trade leveraged becasue I like the kick, but this year I'm down overall, and waiting for the market correction. Just hope I don't chase my losses!

Jun 03 03:30 PM

[Uday Maitra:]

kkerr, interesting link. To your comment, the bull (or bear) will never go to 0 as long as the one-day down (or up) move is less than 33.33% (ignoring management costs) for the 3x levered etfs and 50% for the 2x levered etfs. But, that won't stop anyone of the more volatile lines like FAS or FAZ from trading in pennies. Currently, they are down by -80% in the 6 months since launch. In another 6 months, if the same volatility continues, they could potentially be down another 80%, or i.e. 96% since inception and so on every year. If such a volatile etf started trading at 100, then after a year it can be hypothetically 4, and after the second year it can be hypothetically 0.16 etc.

Jun 03 05:38 PM

[kkerr:]

Well, here is a simulation of a FAS using 3x XLF during the bull market of 2003-2007.

www.quantumfading.com/...

The hypothetical results:
FAS: +500% (20 to 100)
FAZ: -97% (20 to 1)
XLF: +100% (20 to 40)

Jun 03 10:59 PM

[kkerr:]

Funds are like a gun. Whether they are 1x or 3x, they all can kill.

Jun 03 11:28 PM

[harammph:]

Uday, fling stats around all you want. Fas, Up, almost 300% off its lows, as of yesterday and
was up 400% in May.


Down 80% since inception? there were/are a hell of a lot more Financials in that predicament.

You see Down 80%, I see up 300%.

I win.

Jun 04 01:25 AM