Editor's note: Seeking Alpha is proud to welcome Warwick Langebrink as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click
Pricing Of Leveraged ETF Decay - PART 1 : A Different Approach
Summary
- TQQQ is practically perfectly correlated to QQQ on a daily basis. However, TQQQ shows very poor correlation to QQQ when 3-year price movements are considered.
- Polynomial techniques (which incorporate compounding) should be used to price TQQQ and Decay and also to get TQQQ to correlate to QQQ for long-dated (3-year) price movements.
- Solving the 3x tracking (correlation) problem allows us to accurately solve TQQQ costs and compare these costs to e.g. the overnight funding costs of a 2/3 QQQ geared position.
- We can then compare and analyse these 2 strategies (which have very similar return characteristics) and decide which (if any) is better for investment.
- Thesis: The poor long-term correlation problem is due to highly variable LETF Decay costs in different market conditions. Volatility appears not to be the primary driver of Decay.
Chartered Accountant, CFA, Instrument rated pilot, mountain-biker (stage races), 30 years experience as a "quant" in Investment Banking: Specialized Finance and more recently hedge fund type boutique (Acacia) , fixed Income securities trading, product design, modeling, marketing to corporates, product implementation and execution. Recently involved, assisted in the establishment of an offshore pension fund / retirement scheme in partnership with a niched international bank, including retirement scheme statutory and regulatory aspects, legal implementation, marketing, investment philosophy and strategy. Financial areas of interest: Arbitrage, ETF investing, Long/Short Equity, Bonds. My area of writing interest is quantitative analysis, finding potential arbitrage opportunities, behavioral finance miss-pricings which are likely to lead to market corrections (sometimes requiring a contrarian investment style), macro economics, "exploring where no man has explored before" in quants, leveraged ETFs.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of TQQQ, QQQ, VOO either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.