Arnbjorn Ingimundarson

How to Use Leveraged ETFs to Your Advantage

wheelsnaustin,

The math does not work the other way. To use a comparable example, let's say the index goes from 1 to 1.2 and the leveraged fund goes from 1 to 1.4. The index would have to drop 1/6th to go back to 1. The leveraged fund would in that instance drop by a third, which would leave it lower than it started (0.933).

How to Use Leveraged ETFs to Your Advantage

F. Bradeen, I think your comment is problematic. I will address the points you mention.

The charts and return numbers I showed for SSO and SDS included the distributions. For someone who is selling calls on those ETFs, distributions are a good thing as they will limit the price increases of the funds, although the option prices should take this into account.

This article gave a conceptual trading idea and explained the reasoning behind it. I gave an example of the mechanics of the trade in the article for the sake of clarification, I was not trying to give a precise prescription for a trade. Specific expiration dates and strike prices would depend on each investor's expectations for overall market movements and risk tolerance and should take into account how the trade fits into a portfolio. Furthermore, a bear call spread on SDS is just that. "Bearish" in this context refers to the instrument in question, not your overall market sentiment. A careful reading of the article would show that writing calls on both SSO and SDS, in the expectation that neither would rise a lot over an extended time period is exactly what I want. If you want to pay me for investment advice, you may ask me to give more specific trading recommendations. Otherwise you will just have to take or leave what I write.

The last part of your comment makes no sense. You have to factor in the probability of each outcome and the maximum gain is obviously much more probable than the maximum loss. Using your logic, shorting stocks would never be a good idea since the most you can gain is 100% while the loss is unlimited. Also, if you were to write calls on both SSO and SDS, you would be getting roughly twice the premiums while keeping the maximum loss about the same, which changes the gain/loss ratio a lot. However, if you do not like the trade after a careful analysis of it, by all means do not make it.

How to Use Leveraged ETFs to Your Advantage

guruji, thank you for the correction. It is, of course, a net credit (income generating) trade and I also managed to botch the break even price (I was adjusting the option prices from intraday to closing prices and forgot to adjust the price in the text). I will correct this on my blog as soon as I get a chance. My apologies for the sloppiness.

jsgilbert, it is possible to short the ETFs and it could make sense to short them for the long-term. I prefer the approach I outlined in the article as you can profit on the trades if the ETFs stay unchanged or even if they move against you, as long as the change is not too drastic. It also takes up less capacity in a margin account and has a specified end date.