leveraged etf's on dow/s&p?

[stockmarketbeginner]

Hello,

I saw this on investopedia:
"Ultra Dow30 is a leveraged ETF that seeks to replicate two times the daily performance of the DJIA. The fund invests in a number of securities to achieve its objective. Investments include equity securities from the index, derivatives including SWAP agreements and futures contracts, and money market instruments for short-term cash management.

As of December 21, 2017, DDM was trading at $133.22 with a YTD return of 59.28%. The ETF’s three-year annualized total return was 26.67%."


I believe a modest assumption would be for the Dow to rise 10% this year (I think it is up about 2.5% already). So you would get 20% using the DDM.

It seems like a vote of confidence. If you are willing to expose $10,000 to a normal Dow index, then you should be willing to expose $5000 to a 2x multiplier like this one. So if you were planning on taking out a $10,000 position on the DJIA, you could use the DDM instead and free up $5000 for something else. Your loss ratio doubles, but your capital is half, so the total dollar loss on a downturn is at parity.

I know, I know... there is something I'm not getting. So what am I missing here?

 

[DaveV]

As long equity prices keep climbing straight up, as it did in 2017, you will do great with DDM. But if prices go down, or even stay the same but the market is very volatile, you will get killed in DDM. Leveraged ETFs are not really design for long term investments. Here's an example using a bit of simple numbers to demonstrate the math: Let's say the price of DIA is $100 and drops 10% one day. The value of DIA is now $90. On the same day, since DDM is 2x, its value would drop 20% from $100 to $80.
The next day DIA goes up 10% so the value of DIA goes from $90 to $99. DDM is 2x so its value goes up 20% from $80 to $96. Net result: DIA has lost 1% of its value, but DDM has lost 4%.

I think that you will see from this example that if the market is extremely volatile, DDM could significantly under perform DIA.

 

[stockmarketbeginner]

As long equity prices keep climbing straight up, as it did in 2017, you will do great with DDM. But if prices go down, or even stay the same but the market is very volatile, you will get killed in DDM. Leveraged ETFs are not really design for long term investments. Here's an example using a bit of simple numbers to demonstrate the math: Let's say the price of DIA is $100 and drops 10% one day. The value of DIA is now $90. On the same day, since DDM is 2x, its value would drop 20% from $100 to $80.
The next day DIA goes up 10% so the value of DIA goes from $90 to $99. DDM is 2x so its value goes up 20% from $80 to $96. Net result: DIA has lost 1% of its value, but DDM has lost 4%.

I think that you will see from this example that if the market is extremely volatile, DDM could significantly under perform DIA.

Thanks. That is an important point.

 

[DaveV]

I am afraid that you math is wrong on the leveraged ETF. It should be:

Day 1: stock starts at 100
Day 2: stock goes up 10%, now 120
Day 3: stock declines 10%, now 96 (not 108 as in your example)

 

[lindq]

Thanks. That is an important point.

Yes, but I wouldn't let that dissuade you from using the instrument to keep some exposure to the market.

 

[shatteredx]

2x is kids' stuff.

real men buy 3x etfs.

http://www.proshares.com/funds/udow.html

why buy ultra dow when you can buy ultraPRO dow?

you're a pro, aren't ya?

 

[S2007S]

Forget the 2x....go with the 3x ....seems the market only moves one way, UP ...as long as the fed keep priming the markets there is zero risk and all reward.....they should just make 4x and 5x ultra ultra bull ETFs, I mean there is zero risk in this market so why not quadruple your money ....haaaaa


But once that bear market comes these 2x and 3x ultra bull ETFs will be ripped to shreds just like the bear 2x and 3x have been ripped to shreds the last decade

 

[rvince99]

I am afraid that you math is wrong on the leveraged ETF. It should be:

Day 1: stock starts at 100
Day 2: stock goes up 10%, now 120
Day 3: stock declines 10%, now 96 (not 108 as in your example)

This is a critical point -- that leveraged (ad short, even if 1x) ETFs have a mathematically-induced downward drift (due to regular rebalancing). If you truly wanted 2X over a period of time (beyond 1 day), you would buy the 1X SPY on margin, and pay the carry vs the dividends on it.

Perhaps this next opint is worthy of a separate thread (and I am NOT longer-term bearish here) but bear in mind that rebalancing a levered ETF is the same mechanics in terms of quantity adjustments as portfolio insurance, pointed to as the culprit for Oct '87. On that note, there is a hell of a lot more portfolio insurance in today's environment than there was coming into 10/19/87.

 

[DaveV]

I agree. I prefer buying on margin to buying the 2x or 3x leveraged ETFs.
Another possible way to use leverage is to buy deep in the money calls. The premium is usually very low on these options.

 

[stockmarketbeginner]

I agree. I prefer buying on margin to buying the 2x or 3x leveraged ETFs.
Another possible way to use leverage is to buy deep in the money calls. The premium is usually very low on these options.

Thanks, Dave.

How does buying deep in the money calls increase leverage? I'm guessing it is something like this:
The current price is 2.00 per call option. But when it is deep in the money, the price of the call option tracks the price movement of the stock linearly or near-linearly. So if the stock goes up $1.00, then the option value goes up to $3.00. But this represents a 50% increase in value for a comparatively small movement in the price of the stock.

Is that the idea?