You need to take into account the daily rebalancing of leveraged funds. These funds do NOT necessarily return 2x or 3x over time, just 2x or 3x the daily move. You need to do the math on the impacts of this in various paths taken to that final price point. You may very well get much less than 2x or 3x by the time you reach your final destination.
Ouch! SEC to put the crimp on leveraged ETFs.
- Thread starter lindq
- Start date
This is part of the problem...the media has turned everyone against leverage by turning daily rebalancing into some sort of boogeyman but the truth is that daily rebalancing is not nearly as horrible as everyone makes it out to be and can work equally for or against you depending on whether a market is trending or ranging.
Compare any leveraged fund to its 1X counterpart and you’ll see that over the long term the tracking is mostly fair and reasonable. Besides if I can get nearly 8:1 odds that the Energy sector will recover and only have to risk a few basis points due to balancing...still seems fair to me...seems rather unfair to whomever is on the other side of that.
http://apbideas.blogspot.com/2015/12/defending-leverage.html
I don't think its a boogeyman at all, but from your original statement and even from this one it appears that you don't really understand how it impacts returns. Its entirely possible that your underlying could double over the course of a year and the 2X or 3X fund tracking that could be lower than it was at the beginning of the year. You're not getting 8:1 odds and you're not losing a predictable number of basis points to the rebalancing. Rebalancing is not a loss, in fact most of the 2x and 3x funds do a great job of almost exactly tracking the daily performance of their underlying. Its simply a mathematical method of determining returns which leads to nonobvious long term results. The truth is that over a long time period you're getting essentially random results that have little connection to the underlying. Its easy to see exactly what's going on by constructing an excel spreadsheet with a random underlying and how the 2x, 3x, or inverse responds. You'll be surprised by the results, I certainly was the first time I did it. If you want actual 2x or 3x returns you'll need to rebalance daily in the opposite direction that the ETF did or if you can invest in the underlying futures or even more complicated the options.
It's not a bogeyman and daily rebalancing can significantly affect your returns to the point where an overall favorable move in the index can net you a loss. All leveraged etfs that rebalance daily are intrinsically short volatility. The higher the leverage the greater your volatility short. Leveraged short etfs have higher short volatility exposure than the equivalent leveraged long etf.
Yes, Amalgam that is an excellent way of putting it...you are inherently short vol when invested in a leveraged ETF. Would you say that the position would perform similarly to that of a Covered Call?
Buying a 2x levered etf would be like buying the underlying with 2:1 leverage then selling a call for $0.00 and delta hedging it perfectly so that your only loss associated with the option is from realized vol.
However you don't delta hedge out the original 2:1 purchase just the option deltas.