Kevin Stecyk

Leveraged ETFs: Handle with Care

On Mar 26 04:50 AM limps wrote:

> Kevin, your advise is completely flawed. Your comment is just an
> explanation of how maths work.

And it's all about math. If you read the article carefully, you'll note that ProShares walks you through the same math. Again, it's just math, and rather simple math at that.

Leveraged ETFs: Handle with Care

On Mar 25 03:11 AM aarc wrote:

> There is something wrong with the author's analysis. He made his
> conclusion based on a non-trending market with daily ups followed
> by daily downs. Markets don't stay in consolidation forever. They
> do trend too. Make another computation based on trending markets
> with more up days than down day during the upturn and the inverse
> during downturns.

Markets are never linear forever. If you buy and hold, you will NOT achieve 2X or 3X. If the markets trend for a period, buying a 2X or 3X will give you more gain, obviously, then just holding the underlying asset.

Earlier you wrote, "We don't have historical data yet of the xETF to the upside." You don't need historical data on the upside. You can create your own proxy data. You will be missing the expense and tracking errors; however, you will have all the data you require to see the erosion of the 2X or 3X ETFs.

You can look at crude oil or S&P 500 or whatever. There's lots of historical data to play with.

Just use the methodology provided in my table with actual data. And then run it out for a year's period.

Leveraged ETFs: Handle with Care

In my previous reply to David Hollinbeck, I provided two links to Yahoo. Unfortunately, they didn't work out. So here they are again.

-----
David, by looking at SPY and SSO for the three month period, we note that the effect is not pronounced.

See here: bit.ly/18E832 (spy, sso, sds ... fixed link)

Let's look at six months: bit.ly/12wajJ... (spy, sso, sds ... fixed link)
------

Continue with my prior response to David. It's about nine or ten responses up.

Leveraged ETFs: Handle with Care

On Mar 24 08:59 PM Vanderpool wrote:

> This is the best article about these funds I have read yet... Thanks
> Kevin for the effort.

My pleasure.

Still I have some questions...
> What I do not understand is what effect do they have on your holdings
> if you stay in them overnight. Do they open up the next morning compensating
> for any plus or minus action that occurred since closing the previous
> day?

My understanding is that they do compensate for any plus or minus action that occurred since the previous day. So in other words, if the markets open up big the following day, your 2x ETF should reflect that when trading begins.

You would have to read the prospectus of the ETF in question, but my *guess* is that most of these ETFs use a few stocks/futures/options during the day to keep the ETF tracking the underlying asset. And then toward the end of the trading day, they attempt to "true up" the ETF by using a more comprehensive suite of assets.

Some speculate that the wild trading that often occurs in the last hour is attributable to these ETFs.

> Can they be used at all to protect you from overnight swings in the
> market?

I suppose if your portfolio had a beta of 1.0 (or pick any value) and you went with a negative 2X (or whatever value) S&P ETF, it would help flatten your exposure.

That said, these ETFs do experience tracking errors.

> If not, how do you trade in these if you have a long term perspective
> on where the market is headed? (In them in the AM and close out
> in the PM? Everyday until your market expectations change?) How
> do you capitalize on their potential to out perform?

If you believe that the market is headed up (or down), go ahead and buy a triple ETF. Just recognize that volatility will eat away at your returns. So if you have a strong few days and expect the next week to be choppy, sell.

Or buy the ETF in the AM. Ride the ETF throughout the day and sell before closing. In the morning, assess whether you believe that the day will be another winner. If so, buy again. If not, stand aside.

It's the volatility that will eat away at your returns. If you believe that you are about to enjoy several days in a trend, go ahead and try to capitalize on that.

Leveraged ETFs: Handle with Care

On Mar 24 08:21 PM Nic Horns wrote:

> Kevin,
>
> I understand performance drift, I trade the BGU and it is down 50%
> since inception on 11/5 and the Russell 1000 is down 12.9%. At 3X
> that should be a 38.7% decline in the BGU. In order to combat the
> negative volatility effects, do you think coupling the levered ETF
> with a long VIX ETF or option would be a good idea?

To be honest, I don't know. One person who knows these ETFs, VIX products and options well is my friend Adam Warner. I encourage you to follow his blog Daily Options Report at:

adamsoptions.blogspot.com/

He might be able to provide a better and more informative answer.

Leveraged ETFs: Handle with Care

Shaun wrote:

> My bad... I plugged in wrong numbers for +1X. But what about -1X
> ETF. It seems -1X will be same as +2X on even days.
> Day Price +1X -1X

Yes, your math works. Again, my example is quirky in that we have +25%, -20% alternating back and forth.

The key takeaway from this entire exercise is that using a levered ETF, your actual return will differ from an "intuitive expected return," where the intuitive expected return is the ETF multiplier times the actual realized return of the underlying asset. This difference is magnified by both volatility and time.

Leveraged ETFs: Handle with Care

Shaun wrote:

> This implies that even 1X ETFs that simply move based on daily performance
> of the underlying will be off by about 51% on the 10th day (+1X)
> and by about 75% (-1X) when the underlying would be exactly at the
> same price as on Day 0. Does this suggest we only invest in stocks
> and forget about ETFs?

Sorry Shaun, but I don't follow your 1X ETF will be off statement. A 1X ETF should be very close. That is SPY should be very close the S&P 500. SPY is an ETF.

Leveraged ETFs: Handle with Care

David Hollinbeck wrote:

> I have charted the SPY vs. SSO over a 3 month period and don't see
> the effect you are saying will happen. During this past 3 month period
> the SPY has gone down but recovered to the starting value on two
> occasions. On those occasions the SSO has also recovered to its starting
> value. So, I don't see the behavior you are predicting.

David, by looking at SPY and SSO for the three month period, we note that the effect is not pronounced.

See here:preview.tinyurl.com/4d... (spy, sso, sds)

Let's look at six months: preview.tinyurl.com/4d... (spy, sso, sds)

Again, SPY and SSO actually look as though they are performing reasonably well. That is, SSO has fallen roughly 2x as much as SPY. Looking at SPY, though, shows that it is reasonably straight. It has gone down consistently.

However, look at SDS and SSO. Both added together should equal 0. 2X + -2X = 0. On my screen ~+10 + ~-60 doesn't equal 0.

The key to understanding how much these levered ETFs will deviate away from 2X (or -2X or 3X or -3X or whatever) is look at the volatility of the underlying asset and length of time. And, as an additional spot check, add the mirror (if you using +2X, look at -2X) ETF to see if you get 0.

Look at FAS and FAZ. When added together, even over a three month period, you'll note that the two ETFs don't come close to 0. The financials have been much more volatile.

Again, the two main keys are volatility of underlying asset and length of time held.

Leveraged ETFs: Handle with Care

> ...IF you hold them long-term, across a volatile period with many
> up and down days. Caveat, caveat, caveat!

Good, we agree with the caveats.

> However, if you follow trend & buy the rallies and declines,
> you add alpha on both sides, plus downside protection with these
> investments. In the Bear Mkt, longer term and with a number of smaller
> up periods, SOME Ultra value was eroded from my Bear Model (total
> 8-10% allocation) in the 9 months these investments were IN. But
> those 2x Inverse ETF reduced losses considerably, and then the 2x
> Bull EFTs provided great upside after Nov 20th. How many managers
> with a 50/50 > 65/35 > 50/50 allocation suffered a max loss of -10%,
> before gaining back and ending +15% for 2008?

I am not going to attempt to follow all you precise timings of the market. If you are an exceptional market timer, then to really juice your returns, you could use options and futures. That'll give you some alpha.

Speaking of which, Google Daily Options Report, a blog written by my friend Adam Warner. In his blog articles, he discusses these ETFs and options gamma.

To save you the search, you can find his blog here:
adamsoptions.blogspot.com/

The point of my article--and many similar articles--is that investors/speculators should *NOT* think they can *buy-and-hold* these leveraged ETFs and expect to maintain their 2X or 3X leveraged results. As we agreed on the caveats, that won't happen.

> Since anticipating & reallocating for a Bear Rally on 3/9/09,
> the weighted US equity return in my model is UP +36% with four 2xleveraged
> Bull ETFs; the SPY is UP +17.7%. When the Rally fades, Bull ETFs
> go bub-bye. What's so complicated about that?

Yes, if you are using these leveraged ETFs for short-terms directional moves, then great--you're using them as you should. Again, the point of my article was aimed at long term buy-and-holds.

> In small measure these are a market timing godsend - or PITA, if
> you time poorly. The triple 3x leveraged ETFs are probably far too
> risky for the vast majority of investors, but for diversified allocators
> a10-20% Bullish or Bearish stake can significantly improve performance
> in period rallies & declines. You're only as good as your calls,
> same as it ever was!
>
> The mutual fund industry HATES the attention these leveraged ETFs
> are getting, as little financial advisors learn how to outperform
> $$$ fund managers. Also wonder if State Street Global Advisors resents
> the billions now flowing to ProShare Advisors LLC.
>
> Shilly blogs are a good way to attack the competition, obv.

Not sure what you're referring to with regard to "the competition." I don't compete in any fashion with ProShares. In fact, I even gave it kudos for its disclosure that its leveraged ETFs should NOT be used for longer term buy-and-hold investors. Instead, leveraged ETFs are meant for daily or very short-term holding periods.

Even though you seemed to have taken exception to parts or all of my article, I am glad you took the time and effort to post your response. All comments help to clarify this topic for others.

Leveraged ETFs: Handle with Care

> hi kevin, how come add another article warning investors to be careful
> with leveraged etfs? there's been an overabundance of these warnings
> posted here already. -cheers

I agree, there's a lot of articles already highlighting this information. So my article is NOT breaking new ground. But, as mentioned in my article, friends and acquaintances are still under the wrong impression. It was for them that I wrote this article. Now, when I meet those people, I can provide a verbal explanation and point them to an article on my blog.