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 -3X 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, and finally concludes about the current market conditions. The analysis is also valid for the Direxion Daily S&P 500 Bear 3X Shares ETF (SPXS), which tracks the same index with the same factor and has almost identical behavior.
Why do leveraged ETFs drift?
Leveraged ETFs often underperform their underlying index leveraged by the same factor. The decay has essentially four reasons: beta-slippage, roll yield, tracking errors, management costs. Beta-slippage is the main reason in equity leveraged ETFs. However, when an asset is in a steady trend, leveraged ETFs can bring an excess return instead of a decay. You can follow this link to learn more about beta-slippage.
Monthly and yearly drift watchlist
A few definitions are necessary before going to the point. “Return” is the return of a leveraged ETF in a given time interval, including dividends. “IndexReturn” is the return of a non-leveraged ETF on the same underlying asset in the same time interval, including dividends. “Lv” is the leveraging factor. “Abs” is the absolute value operator. “Drift” is the drift of a leveraged ETF normalized to the underlying index exposure in a time interval. It is calculated as follows:
Drift = (Return - (IndexReturn x Lv))/ Abs(Lv)
“Decay” means negative drift. “Month” stands for 21 trading days, “year” for 252 trading days.
Index | Lv | Ticker | 1-month Return | 1-month Drift | 1-year Return | 1-year Drift |
S&P 500 | 1 | 1.59% | 0.00% | 30.24% | 0.00% | |
3 | 3.95% | -0.27% | 48.76% | -13.99% | ||
-3 | -5.73% | -0.32% | -77.74% | 4.33% | ||
ICE US20+ Tbond | 1 | -6.82% | 0.00% | -4.42% | 0.00% | |
3 | -19.56% | 0.30% | -25.99% | -4.24% | ||
-3 | 21.22% | 0.25% | -15.25% | -9.50% | ||
NASDAQ 100 | 1 | -1.66% | 0.00% | 53.86% | 0.00% | |
3 | -6.16% | -0.39% | 135.35% | -8.74% | ||
-3 | 2.91% | -0.69% | -87.78% | 24.60% | ||
DJ 30 | 1 | 2.24% | 0.00% | 22.68% | 0.00% | |
3 | 6.11% | -0.20% | 18.01% | -16.68% | ||
-3 | -7.55% | -0.28% | -75.92% | -2.63% | ||
Russell 2000 | 1 | 4.26% | 0.00% | 48.55% | 0.00% | |
3 | 11.27% | -0.50% | 73.75% | -23.97% | ||
-3 | -14.75% | -0.66% | -90.05% | 18.53% | ||
MSCI US REIT | 1 | 2.78% | 0.00% | 2.33% | 0.00% | |
3 | 7.51% | -0.28% | -44.21% | -17.07% | ||
-3 | -9.26% | -0.31% | -68.02% | -20.34% | ||
MSCI Emerging | 1 | -1.03% | 0.00% | 34.25% | 0.00% | |
3 | -4.10% | -0.34% | 61.20% | -13.85% | ||
-3 | 0.56% | -0.84% | -79.35% | 7.80% | ||
Gold spot | 1 | -6.21% | 0.00% | 5.07% | 0.00% | |
2 | -12.74% | -0.16% | -1.99% | -6.07% | ||
-2 | 13.04% | 0.31% | -18.73% | -4.30% | ||
Silver spot | 1 | 5.29% | 0.00% | 49.73% | 0.00% | |
2 | 7.22% | -1.68% | 61.03% | -19.22% | ||
-2 | -16.64% | -3.03% | -77.65% | 10.91% | ||
S&P Biotech Select | 1 | -2.82% | 0.00% | 69.37% | 0.00% | |
3 | -11.68% | -1.07% | 155.06% | -17.68% | ||
-3 | 1.46% | -2.33% | -93.50% | 38.20% | ||
PHLX Semicond. | 1 | 6.95% | 0.00% | 86.00% | 0.00% | |
3 | 16.80% | -1.35% | 204.34% | -17.89% | ||
-3 | -24.25% | -1.13% | -96.19% | 53.94% |
The inverse leveraged silver ETF (ZSL) has the worst monthly decay of this list with a drift of -3%, followed by the 3x inverse biotechnology ETF (LABD) with -2.3%
The worst 1-year decay is in the leveraged inverse T-bond ETF (TMV) with -9.5%, followed by the leveraged Nasdaq 100 ETF (TQQQ) with -8.7%.
Negative drift comes with daily return volatility (“whipsaw”). Whipsaw happens more often in downtrends: downtrends make investors nervous, so steady downtrends are very rare.
Positive drift follows a steady trend in the underlying asset, whatever the trend direction and the ETF direction. It means positive drift may come with a gain or a loss for the ETF. However, it often happens in a large loss by compounding leveraged negative daily returns: this is the case for all positive yearly drifts in the table above.
SPXU historical drift
Trading or hedging with SPXU has worked very well in the first week of the 2020 market meltdown (2/21 to 2/28/2020): it has gained about 40%, significantly more than SPY return on the same period of time (-11%) multiplied by the leveraging ratio (-3). It is a significant excess return due to beta-slippage. I had issued a warning on 3/10/2020 against leveraged equity ETFs. In a few weeks, SPY lost 17.5% and SPXU gained about 16% at the same time: less than shorting SPY without leverage. Since then, the monthly drift has oscillated between positive and negative values, but the 12-month drift has stayed negative until last month. It just came back in positive territory.
12-month drift of SPXU since 12 months after inception (6/23/2009)
Conclusion
SPXU and SPXS are cheap hedging instruments in a bull market compared with other derivatives. However, they may suffer a significant decay when S&P 500 daily returns are volatile (realized volatility). The VIX index (implied volatility) may also be an indirect warning of leveraged ETFs decay. SPXU 12-month drift became strongly negative in March 2020, and it was better to avoid it since then. It is positive again, but the monthly drift is negative due to recent volatility, which is a reason to stay cautious.
In volatile times, instruments with less or no leverage should be preferred for hedging. The real drift of a hedging position depends on rebalancing dates. Rebalancing close to technical support and resistance zones may partly or totally offset the drift, but this is path-dependent and unpredictable.
Shorting an asset or buying an inverse product also implies a decay due to the inflation rate. It is not yet a concern for now, but keep it in mind.
Anyway, leveraged ETFs are only for investors and traders with a good understanding of the products behind the advertised leveraging factor. If you have a doubt, stay away.
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