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Pricing Of Leveraged ETF Decay - Part 2

Warwick Langebrink profile picture
Warwick Langebrink


  • Leverage has been used by financiers to make fortunes in Private Equity, Hedge Fund Management and Investment Banking - particularly where they are able to control the narrative.
  • Wholesale (inexpensive) financial leverage has historically (until recently) mostly been out of reach of retail investors. LETFs and availability long dated options now allow retail investors access to financial leverage.
  • But misapplied or misunderstood leverage can go horribly wrong and amplify losses.
  • Leveraged ETF Decay costs (including interest costs) are at all-time lows, which can support an LETF "positive gearing effect."
  • But investors should be prepared for a spike in LETF decay costs (in multiples).  Investors should also understand that some LETFs leak (decay) a lot more than others.

XXL desert road thunderstorm

sharply_done/E+ via Getty Images

This article seeks to further analyze decay pattern correlations between Long and Short Leveraged ETFS (LETFs); to briefly explore the relationship between various leading LETFs; to analyze cost relationships between 2X and 3X LETFs over time, and over various market

This article was written by

Warwick Langebrink profile picture
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, SOXL, SPXL, QLD, SSO 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.

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Comments (49)

excellent article
On TQQQ, would a holding period of 30-40 years outweigh the vol and decay risks?
Warwick Langebrink profile picture
@Faangtom Good question. in a very brief nutshell if QQQ runs at 10% per year (growth partly driven by Fed money printing (stimulus) and inflation (iphone prices and profits increasing) the TQQQ should run at roughly 3X 10% = ~30% per year (actually the correct formula is ((1+ 10%) ^3-1)) in the long term before considering any leakage. (however investors can expect a very bumpy ride along the way). I will run the exact past 10 year average leakage numbers for TQQQ but my initial knee-jerk gut feel from the charts is that average TQQQ leakage will be well below 30%. (positive gearing effect) I do however think that the 2X LETFs SSO and QLD offer much lower leakage relative to market exposure at the moment and with the FED now aggressively withdrawing stimulus (hawkish Fed policy) i am now (in February 2022 conditions) favouring, rebalancing in favour of the 2X SSO and QLD. please have a look at my latest article: Time to de-risk , optimise LETF exposure. seekingalpha.com/...
@Warwick Langebrink ya I read your other article. Maybe you can run the past 20 - 30 years if possible.
FrankEllis profile picture
Take into consideration the secular cycle at which you are looking. This twenty-year secular Bull cycle began on April 19, 2013, and offers very different info and conclusions from the thirteen-year secular bear cycle that started on March 23, 2000. Information from diametrically opposing cycles is incompatible. It is mixing apples with elephants, comparing dissimilarities. Beware.
I invested all kinds of 3xLEFTs exclusively for years and made a high fortune. I still work and so have little time to optimize among various LEFTs. Overtimes, I developed personal hedging, just to reduce volatility, and that is to keep PSQ to 25% of growth sector size. As said, it is just to reduce volatility so as not to be fainted. It apparently saved the health of my heart and artery.
Warwick Langebrink profile picture
@seagulljonathan Staying long LETFs : Good call. I hope that the current market downturn doesn't last too long.. As you say: During downturn , put LETFs in the bottom drawer and forget, go on holiday and look at them again in a couple months. Knee-jerk sell decisions in times of distress usually turn out to be wrong decisions in hindsight. Thoughts on PSQ: PSQ 1X short QQQ is a lot less expensive in leakage/decay costs than SQQQ (when holding costs are measured on an appropriate equivalent delta, gamma hedge basis (i.e when measured with equivalent QQQ hedging exposure)) and preferred over SQQQ if u have the cash. However Short QQQ obviously dilutes your long returns: Goldman Sachs gets worried if their Value At Risk, Volatility , Market Exposure is too low (not high). Increased VAR, Vol, Market Exposure = increased profits. www.amazon.com/... Market down-Turn: My strategy: Hook in and hold on, ride out the storm, dont sell (heart-attacks aside).
Anson J. Glacy Jr., CFA profile picture
Clear air? Really? With the level of financial malfeasance emanating from Washington every day? And a vicious global competitor plotting our downfall?

The past 39 years have been one scenario out of many that could have occurred. To say that these sample points have predictive value going forward is a thin reed.
Warwick Langebrink profile picture
@Anson J. Glacy Jr., CFA Thank you for your comments. Good to have debate, test viewpoints, assumptions. For every bull there must be an equal numbers of bears (otherwise the price would move to correct the imbalance)

As per my opening paragraph investors should formulate their own independent opinions on Nasdaq and S&P outside my article: LETFs should only be used for investors conclusively bullish on the Nasdaq 100 or S&P 500 or other underlying indices, and for investors seeking to take advantage of the low gearing costs imbedded in LETFs ("positive gearing effect").

"Clean Air": refers to LETF costs being at an all time low at the moment, and sentiment is that this situation may continue to 2024 which is positive for LETFs (but investors should prepare for spikes in hedging costs in multiples ("thunder storms") for a myriad of reasons , including yours above, many unforeseen / unforeseeable.

In the very long run equities (hard assets) are suggested as a better inflation hedge than bonds / cash by greater wisdom/minds than mine: Lyn Schwartzer SA articles are well worth a read:
"3 Types Of Inflation, And How They Impact Your Portfolio"
"Investing With Inflation: 150 Years Of Data"
"QE, Wealth Concentration, And Political Risk"
Anson J. Glacy Jr., CFA profile picture
@Warwick Langebrink I'm not a bear. Actually I'm a dedicated QLD investor. But I do think that what we showed in Afganistan and the actions of Jay Powell matter miles more than LETF fund drag.

If China were to move on Formosa, QQQ would drop by 50% and QLD by 70%. Just my opinion, of course.
Warwick Langebrink profile picture
@Anson J. Glacy Jr., CFA Agreed. Article looks to compare TQQQ vs QLD vs QQQ as possible investment strategies (not promote QQQ as an investment). From Part 1: "The main thrust of this article is to analyze TQQQ imbedded costs relative to QQQ as a possible catalyst for TQQQ investment. The objective of this article is not to attempt to convince prospective TQQQ investors of likely market growth prospects of Nasdaq 100 – there is far greater minds and readily available collective wisdom on this topic), but I have briefly included my personal views on Nasdaq 100 and QQQ’s growth prospects, mostly based on others analysis’ views and analysis that have made sense to me, and my notes at the end of this article are accordingly brief." "..TQQQ is not for the faint-at-heart nor for those who do not appreciate the risks, nor those who are not already (prior to reading this article) conclusively bullish on Nasdaq-100."

PS. I support, agree with your QLD investment decision: QLD is a better bet than TQQQ (if you have the capital to spare): one third of the cost of TQQQ and QLD fares better in downturns.

PS: People fixate on the 95 bps annual admin fees for LETFs while the actual costs can be 40 times that in times of market distress (eg 2020). TQQQ's 40% capital leakage (40% value loss to your portfolio) relative to investing in QQQ (with identical QQQ market exposure) is a significant investment decision.
j2myers profile picture
Excellent work.
I own SSO for a while. Added in the 20% correction Oct-Dec 2018 and added more when the world ended again Mar Apr May 2020. I have had 1 2/1 split and another 2/1 coming Jan 13th 2022. Have done very well and I consider SSO a core holding. A friend told me about FAS TECL SPXL SOXL. I started buying those Apr-June of 2020. I have trimmed some but still have some. SOXL went 15/1 and Tecl went 10/1 in splits. Cost basis very low. They have treated me well. I will hold these also.
Warwick Langebrink profile picture
@jzut Well done: SSO is the least expensive of all LETFs. At the moment you are getting practically free leverage on SSO, and even during times of distress your leakage costs are about one third of the 3X S&P LETFs - so good call. I agree with you and would continue to hold.
@Warwick Langebrink

Warwick, I have 20% of my portfolio in ROM and 20% in USD. Do you like this strategy or do you think QLD 40% would be better long term? I chose ROM and USD to be more pure plays than QLD
Warwick Langebrink profile picture
@punjabivestor ROM provides 2x levered exposure to the Dow Jones US Technology Index. ROM is issued by ProShares (a subsidiary of BlackRock), arguably the largest ETF and LETF issuer - which is good. ROM is a 2X LETF which, from a decay, leakage, tracking error, cost perspective, tend to fare much better than 3X LETFs, when compared on an equivalent market exposure basis. [Obviously 2X LETFs require 50% more investment to achieve the same market exposure as 3X LETFs] (3X LETFs sail closer to the wind, can risk under-collateralization, forced closure/restructure in adverse market conditions). I have not run the decay numbers for ROM, but i have run the decay numbers for DIREXION 3X Semiconductor LETF SOXL and my advice on those SOXL is AVOID/SELL/REPOSITION into the unleveraged semiconductor index in current market conditions: SOXL loses nearly 50% (annualized cost) of its investment value per year to costs in current market conditions. I will run the ROM decay if i set some time aside (my bootstrapping models are quite time intensive). I would invest your USD cash into S&P or NASDAQ unleveraged VOO or QQQ to hedge against inflation. Rising inflation (interest rate) expectations have hit high PE stock (IT, FAANG) valuations hard, but I see the fundamental v long term (inflation adjusted) cash producing ability of all these companies as remaining unchanged, bullish, unchanged by fluctuating interest rate expectations (IPhones will still sell in future albeit at higher prices and higher margins for Apple), and I think all interest rate impact has already been factored into latest stock prices. So stocks (in my view) are a much better long term inflation hedge than cash (provided you are willing to sit on your VOOs and QQQs for 10 years and ride out the current speed-bumps. (HOLD - dont sell when there is blood on the streets) . I am just about to publish the latest LETF Decay numbers, and will run through some restructuring ideas in current market conditions (whilst maintaining the same gross market exposure through the dip). People that sell wont catch the bounce.
FrankEllis profile picture
Decay, fees, cost of leverage, and all the other incidentals upon which people focus attention, effort, and time occur before the final price. Therefore, price recognizes and accounts for all the other factors. Analyzing price takes into account everything that happened to determine the price.
The ten-year price gain of the above mentioned 3X ETF's shows profits after all the incidentals are factored into the price over the ten years. Decay, fees, and all the miscellaneous topics of worry are already included in the price.
Ten-year gains after decay, fees, etc are computed:
TQQQ +10757%
SOXL +15757%
SPXL +2648%
UPRO +2847%
TNA +657%

With returns-on-investment like these, after decays, why are we concerned with decay?

And for those who want to bet their money against the American economy, against the consumer, against United States employees and management teams, the Short ETF's:
SQQQ -99.97%
SPXU -99.76%
Warwick Langebrink profile picture
@FrankEllis I agree that costs pale into insignificance in relation to market performance in a bull market, but costs are nonetheless important (even in a bull market) when considering which LETF to purchase and whether to purchase 2X or 3X or perhaps short the SQQQ or similar. When the market is going sideways or backwards, these decay costs and the protection they offer becomes very significant, and a critical component of deciding whether to buy the index or an LETF thereof. As you well know, the LETF version will always underperform in a sideways or backwards market, and the important question becomes "by how much will the LETFs underperform?). I hope that my article will give some insight into the answer to that question.
PauloCostaSilva profile picture
@FrankEllis No one beats you when the topic is LETF's :)
The secret is staying long and surf all the waves. The longer you stay, the better you'll be in this game.
@FrankEllis I like your comments on TQQQ and other leveraged ETF's. Do you think anytime is the time to enter TQQQ or do you wait for a pullback or some sort of signal? Thanks.
mlunacargochernoff profile picture
Wow, this is a well studied, indepth article. I'll have to read it a few times over.
Warwick Langebrink profile picture
@mlunacargochernoff Thank you.

If you are interested, please also have a look at Part 1 which provides the foundation for Part 2.: seekingalpha.com/...
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