Lawrence J. Kramer

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

The investor needs to pass a simple, one question test: If the relative index goes up 5% on Monday and returns to base on Tuesday, where does you ETF end up ? If he says "where I started," he can't buy the thing. Since that test is impractical to administer, and something like 90% (my guess) of retail investors would fail it, maybe pessimists should just be limited to buying puts.

Ultrashort ETFs Can Work if You Trade Them Correctly

Damn. I quit. I apologize to readers. I don't seem able to proof my ups and downs. Seriously, I'm sorry. But if you do the math right, you'll get the results I was trying to show.

Ultrashort ETFs Can Work if You Trade Them Correctly

SB-Tiger: The math on inverse funds makes clear that daily inverse percentage moves will leave an inverse fund below the tracked index over periods of market fluctuation. Because this result is algebraically inevitable, one should not expect accurate tracking and so should not be surprised - or even angry except at oneself - when it doesn't track..

The math is simple. Suppose the index and the etf are both at 100 on Day 0. On Day 1, the market goes up 5% to 105 and your etf goes down 5% to 95. On Day 2, the market returns to 100. What does your inverse do? It goes down 5/95 (the inverse of the 5/95 increase in the index). But 90/95 of 105 is only 99.47, less than 100. Poof, you're tracking is off. Compound that result over several fluctuations, and of course the inverse does not "track."

2x inverse funds are even worse. Same 5% drop in the index produces a 10% gain in the fund. Return to 100 produces a drop of 10/95 from a level of 110, leaving 98.42. That means the index hasn't moved, but you're down 1.58%. Compound that.

The only way out is to trade for a daily burst, or adjust your holdings frequently so that the value of your etf holding as a percentage of your portfolio stays constant.

Ultrashort ETFs Can Work if You Trade Them Correctly

Sorry, I screwed up my example.

Trading, per se, may not the be the key to using Ultrashorts. Balancing one's holdings may be sufficient. For example, if you buy an ultrashort and the index moves down 5%, your ETF should move up 10%. Now ask yourself what would a move in the index back to the day before's level mean to your ETF. The answer is that it would fall by more than it went up the day before, and you'd be out money. If, on the other hand, you sold a carefully computed chunk of the ETF, you could expect that a gain of 5.26% in the index (about what it would take to get back down to the original level), and the resulting 10.52% loss in the ETF, would lose a dollar amount equal to the previous day's gain. My arithmetic says you need to unload about 13.6% of your ETF holding so that the 5.26% gain in the index will lose the same amount of dollars as you made the day before. I may be wrong about this, but It seems to me that balancing one's holdings on a daily basis would give you a pretty good chance of having the ETF do over the long haul what it is designed to do on a daily basis.

Ultrashort ETFs Can Work if You Trade Them Correctly

Trading, per se, may not the be the key to using Ultrashorts. Balancing one's holdings may be sufficient. For example, if you buy an ultrashort and the index moves down 5%, your ETF should move up 10%. Now ask yourself what would a move in the index back to the day before's level mean to your ETF. The answer is that it would fall by more than it went up the day before, and you'd be out money. If, on the other hand, you sold a carefully computed chunk of the ETF, you could expect that a fall of 4.76% in the index (about what it would take to get back down to the original level), and the resulting 9.5% loss in the ETF, would lose a dollar amount equal to the previous day's gain. My arithmetic says you need to unload about 13.6% of your ETF holding to reach that result. I may be wrong, but it seems to me that balancing one's holdings on a daily basis would give you a pretty good chance of having the ETF do over the long haul what it is designed to do on a daily basis.