SPXU Is Still A Dangerous Play
Summary
- Leveraged ETFs may have an unpredictable behavior.
- We show 20+ ETFs as examples.
- We focus on the historical and recent behavior of SPXU.
- This idea was discussed in more depth with members of my private investing community, Quantitative Risk & Value. Get started today »
The ProShares UltraPro Short S&P 500 ETF (NYSEARCA:SPXU) is one of the most popular instruments to short the broad market for trading or hedging purposes. However, its daily leverage factor is a source of drift. It must be closely monitored to detect changes in the drift regime. This article explains what "drift" means, quantifies it in more than 20 leveraged ETFs, shows historical data on SPXU, and finally concludes that it is better to avoid it in current market conditions.
Why do leveraged ETFs drift?
Leveraged ETFs often underperform their underlying indexes leveraged by the same factor. This relative decay has several reasons: beta-slippage, roll yield, tracking errors, management fees. Roll yield may be prominent for commodity ETFs, but beta-slippage is usually the main source of decay. However, it doesn’t always result in decay. When an asset is trending with little volatility, a leveraged ETF can bring an excess return over the leveraged asset. You can click here to learn more about beta-slippage and examples.
Monthly and yearly drift watchlist
A few simple formulas and data definitions are necessary before going to the point. “Lev” is the leveraging factor. “Return” is the total return of an ETF (including dividends). “IndexReturn” is the total return of the underlying index, measured on a non-leveraged ETF (also with dividends). “ETFdrift” is the drift of the ETF relative to the leveraged index. “TradeDrift” is the drift relative to an equivalent position in the non-leveraged index. ETFdrift and TradeDrift are calculated as follows, where Abs is the absolute value operator.
ETFdrift = Return - (IndexReturn x Lev)
TradeDrift = ETFdrift / Abs(Lev.)
“Decay” is negative drift. “Month” stands for 21 trading days, “year” for 252 trading days.
A drift is a difference between 2 returns, so it can be below -100%.
Index | Lev. | Ticker | 1-month Return | 1-month ETFdrift | 1-month TradeDrift | 1-year Return | 1-year ETFdrift | 1-year TradeDrift |
S&P 500 | 1 | 14.89% | 0.00% | 0.00% | -0.90% | 0.00% | 0.00% | |
3 | 45.61% | 0.94% | 0.31% | -34.52% | -31.82% | -10.61% | ||
-3 | -39.25% | 5.42% | 1.81% | -41.94% | -44.64% | -14.88% | ||
ICE US20+ Tbond | 1 | 0.68% | 0.00% | 0.00% | 39.01% | 0.00% | 0.00% | |
3 | 0.91% | -1.13% | -0.38% | 121.09% | 4.06% | 1.35% | ||
-3 | -2.72% | -0.68% | -0.23% | -70.64% | 46.39% | 15.46% | ||
Nasdaq 100 | 1 | 16.69% | 0.00% | 0.00% | 14.06% | 0.00% | 0.00% | |
3 | 52.19% | 2.12% | 0.71% | -1.54% | -43.72% | -14.57% | ||
-3 | -42.51% | 7.56% | 2.52% | -63.82% | -21.64% | -7.21% | ||
DJ 30 | 1 | 13.39% | 0.00% | 0.00% | -7.64% | 0.00% | 0.00% | |
3 | 40.49% | 0.32% | 0.11% | -48.99% | -26.07% | -8.69% | ||
-3 | -37.14% | 3.03% | 1.01% | -33.63% | -56.55% | -18.85% | ||
Russell 2000 | 1 | 17.33% | 0.00% | 0.00% | -19.39% | 0.00% | 0.00% | |
3 | 49.77% | -2.22% | -0.74% | -69.83% | -11.66% | -3.89% | ||
-3 | -47.52% | 4.47% | 1.49% | -16.16% | -74.33% | -24.78% | ||
MSCI US REIT | 1 | 12.69% | 0.00% | 0.00% | -12.30% | 0.00% | 0.00% | |
3 | 31.40% | -6.67% | -2.22% | -63.87% | -26.97% | -8.99% | ||
-3 | -40.40% | -2.33% | -0.78% | -31.70% | -68.60% | -22.87% | ||
MSCI Emerging | 1 | 8.11% | 0.00% | 0.00% | -16.82% | 0.00% | 0.00% | |
3 | 21.69% | -2.64% | -0.88% | -61.37% | -10.91% | -3.64% | ||
-3 | -26.14% | -1.81% | -0.60% | -0.14% | -50.60% | -16.87% | ||
Gold spot | 1 | 6.91% | 0.00% | 0.00% | 33.22% | 0.00% | 0.00% | |
3 | 19.31% | -1.42% | -0.47% | 103.63% | 3.97% | 1.32% | ||
-3 | -20.47% | 0.26% | 0.09% | -64.10% | 35.56% | 11.85% | ||
Silver spot | 1 | 6.91% | 0.00% | 0.00% | 1.53% | 0.00% | 0.00% | |
3 | 13.81% | -6.92% | -2.31% | -30.80% | -35.39% | -11.80% | ||
-3 | -25.65% | -4.92% | -1.64% | -45.89% | -41.30% | -13.77% | ||
S&P Biotech Select | 1 | 23.98% | 0.00% | 0.00% | 7.39% | 0.00% | 0.00% | |
3 | 78.37% | 6.43% | 2.14% | -28.63% | -50.80% | -16.93% | ||
-3 | -54.09% | 17.85% | 5.95% | -65.45% | -43.28% | -14.43% | ||
PHLX Semicond. | 1 | 15.26% | 0.00% | 0.00% | 7.17% | 0.00% | 0.00% | |
3 | 39.91% | -5.87% | -1.96% | -41.07% | -62.58% | -20.86% | ||
-3 | -46.63% | -0.85% | -0.28% | -76.43% | -54.92% | -18.31% | ||
VIX ST Futures | 1 | -18.01% | 0.00% | 0.00% | 53.99% | 0.00% | 0.00% | |
2 | -38.05% | -2.03% | -1.02% | 7.19% | -100.79% | -50.40% |
*TVIX is an ETN with a higher counterparty risk than an ETF.
The best and worst drifts
- The leveraged silver ETF (USLV) and the leveraged real estate ETF (DRN) have the worst monthly decays with drifts of -2.3% and -2.2% normalized to 1x the underlying indexes exposure.
- The highest positive monthly drift is in the inverse leveraged biotechnology ETF (LABD), with a normalized drift of almost +6% in a large loss.
- The leveraged volatility ETN (TVIX) is showing the worst decay in 1 year with a normalized drift of -50%.
- The inverse leveraged ETF in long-term treasury bonds (TMV) has the highest positive drift in 1 year: 15.5%. This is an asymptotic loss pattern: while TLT went up 39%, the -3x ETF has compounded negative returns going closer to zero. It cannot go to zero unless the underlying index goes up more than 33% in a single day.
SPXU is still a dangerous play for now
SPXU has a positive drift on long periods, as reported in this article. However, I have issued a warning on 3/10 (and on 3/5 for my subscribers) against SPXU and generally against leveraged equity ETFs. Trading or hedging with SPXU has worked very well in the first week of the market meltdown (2/21 to 2/28): SPXU has gained 39.98%, significantly more than SPY return on the same period of time (-11.16%) multiplied by the leveraging ratio (-3). It is a 6% excess return due to beta-slippage. Then, whipsaw action has resulted in a heavy drag in a few weeks in March: SPY has lost 17.5% and SPXU has gained only 15.54% in the same time. It means shorting SPY was a better trade than buying SPXU, despite the leverage factor. In April, the drift was positive again (+1.8%). However, it is very far from offseting the previous decay. The next chart shows that SPY and SPXU have the same return in 3 months!
The second chart below shows that the 12-month drift is close to the worst, after going to the best value in 10 years at the beginning of the year.
Moreover, the indicators we are following in Quantitative Risk & Value are not optimistic for stocks: we can expect more volatility and negative drift for SPXU.
SPXU may be a cheap instrument for hedging a portfolio in a bull market compared with other derivatives. However, its drift became negative in March and history tells it may suffer a significant decay as long as market daily returns stay volatile. In the current environment, it is better to use hedging instruments with less or no leverage. The real drift of a hedging position depends on its rebalancing dates. Rebalancing close to technical support and resistance zones may partly or totally offset the drift, but this is path-dependent and unpredictable.
Bottom line: Unless you are a seasoned trader working in hourly or daily time units, stay away from SPXU and all leveraged ETFs for now.
Quantitative Risk & Value (QRV) closely follows risk indicators to get clues about the outcome of this black swan. Besides our usual value and dividend stock lists, we have added a 5-stock mega-cap portfolio to weather the crisis, and some opportunities in closed-end funds resulting from volatility. Moreover, we plan to add a new stock list based on all-terrain quant models to help navigate the future market regime. Get started with a two-week free trial and see how QRV can improve your investing decisions.
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