kkerr

Why Did Deutsche Bank Drop DXO?

Kalani,

I too thought the author was wrong about the lack of tracking due to rollover. I thought it was mostly due to leveraged decay. But, when I ran the calculations in my decay calculator, there is actually relatively little decay in DXO. The decay computed to be 11%. The calculator shows DXO tracking an index that has gained 20%, which is far off from the 47% gain in oil.

So as it turns out, DXO did not underperform due to decay, there really was a tracking problem.

Crucifying Inverse Leveraged ETFs: Why Now?

Roger,

It is called Margin. :)

Nice article Walter. As you stated, the big reason for the Leveraged ETF hoopla recently is because of the incredible day to day volatility that we have seen in the past year. This has resulted in rates of decay that are anywhere from 20 to 40 times normal.

Leveraged ETF Winners and Losers in 2009

Puzzled: Why does it matter how they do vs the underlying index? The only time it matters perhaps is if you are swing trading them or holding them long term.

The Leveraged ETF Debate Continues

vjay: You are correct, it can be done with typical margin. But, for swing traders they do have advantages over margin, such as they protect you from losing more than 100% of your trade. With margin, it takes a 50% drop to blow you out, and any further decline would put you negative.

Restricting Access to Leveraged ETFs - Are Brokerages Outlawing Products or Strategies?

I agree with all of your points. It is my belief that they are being banned due to investors' lack of understanding of how they work for periods longer than a day. With a stock at least investors know there is no potential for loss from some weird 'decay.' However, the counter argument is that options are not trivial to understand either, and they are not banned. Hence, leveraged ETFs should not be banned.

Insincere Concerns: The Banning of Leveraged ETFs

Ron, you made some fantastic points and the discussion has been great. As you said, I think mikey5555 understands how the math works, there just seems to be disagreements on who is 'pocketing the money.'

mikey5555: All I claim is that the leveraged ETFs are doing what the operators want them to do. Since this whole topic of decay is a non-issue if these ETFs are traded intraday as that is what they are designed for, the resulting decay for swing traders is just a side effect that swing traders need to understand if they choose to use this tool in a way in which it was not designed.

It is like trying to drive a ferrari off-road. Yeah you can do it but there will be some nasty side effects to the car. It is not sold to be driven off road. Unfortunately it is not obvious that leveraged ETFs are not sold to be long term investments. Perhaps that is why some brokers are blocking them for their clients.

There are really two approaches to leverage. If you want leverage intraday, it will come at the cost of causing decay interday (long term). If you want to eliminate the decay interday, it will come at the cost of the fund not truly seeking a constant multiple on an intraday basis. The counter argument to the latter is that these ETFs already have this side effect: positions opened or closed intraday that are higher or lower than the day's opening price, effectively increase or decrease the leverage that the position will be exposed to. (A topic for my blog some day). I think that is covered in the funds' prospectus too. The leveraged ETF fund operators have chosen to make the funds work for intraday traders (thus causing the decay for swing traders).

I will also sometime write an article that describes the design a hypothetical leveraged ETF that is not affected by decay. What you will see is absolutely incredible upside profitability potential (compounding up, but no decay to bring it back down!).

And to add to the trending example Ron used, during the bull market from 2003 to 2007, a 3x on SPY (such as UPRO) would gain 430% versus SPY's gain of 85%. This is 5x leverage.

Insincere Concerns: The Banning of Leveraged ETFs

User 464439:

I am sorry but I disagree with you on the idea that the decay is from the leveraged ETFs pocketing money. Yes they pocket some money to make their profit, but it is not even close to the amount the fund loses from decay. I agree completely that if you take two equal points a half a year apart that are equal, the leveraged ETF will be less. That is a guarantee due to the math. It is NOT from the operators pocketing money.

I just wrote an article the other day demonstrating that decay is not specific to the leveraged ETFs. Any similar concept in the world will experience the same decay. I used cyclists as my example in my 5th grade storyline defending how decay is not a flaw:

blog.quantumfading.com.../

My original article on decay also shows examples of 'perfect leveraged etfs' that have no expenses and fees, and how they decay as well:

blog.quantumfading.com.../

The decay is not a flaw, it is just something a trader should thoroughly understand if they choose to swing trade leveraged ETFs.

Everybody Hates Leveraged ETFs

Best quote of the article: "The bottom-line is that long-term and 'buy-and-hold' investors should stay away from these investments or be clear about the risks they carry."

Also, here is another article that explains decay (with charts and graphs):

blog.quantumfading.com.../

Leveraged ETF Ban Spreading Like the Flu

Decay is not a flaw, and here is a 5th grade example to prove it (with some charts):

blog.quantumfading.com.../

Leveraged ETF Ban Spreading Like the Flu

In all fairness to the leveraged ETFs, they experienced incredible decay due to the very high volatility during the November-April time period. They used to decay approximately 10-20% per month. Now that volatility has come down towards more normal levels, things like FAS and TNA are decaying approximately 2% per month since May. So, a positive trend can easily offset such decay. Case in point, TNA is up 33% since the beginning of may. Had there been zero volatility, it would be up roughly 42%. Regardless, the 2% monthly decay has been no match for the uptrend.

With all that being said, if a trader plans to hold them for longer than a day, it is important to understand the risks and how the decay works.

UBS Halts Inverse and Leveraged ETF Trading

Non leveraged inverse ETFs, I mean.

UBS Halts Inverse and Leveraged ETF Trading

Even inverse ETFs are affected by decay, which many do not know. It is amazing how just a simple lack of understanding of a particular tool (Leveraged ETFs) has caused so much commotion.

Absurd Inverse and Leveraged ETF Product Whining (Updated)

There is usually at least one leveraged ETF article on seeking alpha each day, and this is probably the best one yet. It never ceases to amaze me how little people understand how these leveraged ETFs work over longer timeframes, which is indicated in several comments here.

I've written several articles on Leveraged ETFs and decay, and my entire blog (ad free!) is dedicated to leveraged ETF research. I am not an expert by any means, but I did write custom software to analyze how hypothetical leveraged ETFs would perform over decades. Here is an article, which would probably be best titled: "Decay for Dummies"

blog.quantumfading.com.../

I hope this helps... I am on a crusade to help spread knowledge for swing traders.
Kevin

Why Leveraged and Derivatives-Based ETFs Are Dangerous

I agree long term investing in a leveraged ETF is not a wise strategy (since they were designed for day trading anyways). However, they do have some advantages for swing traders. As long as traders understand the risks and the how this 'decay' works, there are some good ways to use these tools. Articles covering Leveraged ETFs and decay pop up about once a day on seeking alpha, which is good. Here is an article (with charts and graphs) that explains decay in simple terms:

blog.quantumfading.com.../

ProShares Study Rebuffs Leveraged ETF Critics

I am glad they are stepping up and debunking the myth that these are only for single day only trades. I've done extensive research on swing trading the leveraged ETFs, and provided my results in three articles that basically confirm their findings:

Leveraged ETF Decay: blog.quantumfading.com.../
Leveraged ETF Compounding: blog.quantumfading.com.../
Measuring Leveraged ETF Decay: blog.quantumfading.com.../

I even provide a crude (but free) utility for simulating leveraged ETFs and measuring decay.

I hate to keep spamming my articles on nearly every seeking alpha leveraged ETF article, but there are just too many misconceptions about how these work over the long term.