
ETFs, Volatility and Leverage: Towards a New Leveraged ETF - smabie
https://smabie.github.io/posts/2019/10/04/vol.html
======
anonu
Leveraged ETFs are not leveraged in the traditional since as one might expect.
The article misses this point and the author should rectify and clarify
immediately.

Leveraged ETFs promise the daily return. They are reset every single day. So
your return over N days is completely path dependent.

Even a positive return of the benchmark may result in a negative return in a
leveraged ETF if that path was volatile...

Leveraged ETFs are trading tools. Do not hold them in your portfolio for more
than a few days.

~~~
max_likelihood
Just curious, what does it mean to say that they are reset everyday?

~~~
nextweek2
You have to return the leverage at the end of the work day. Meaning the shares
have to be sold at the end of the day and then brought again the following
morning.

Meaning you are getting 3x the increase from the start of the work day until
the end of the work day but also 3x the potential loss.

The problem is that you are exposed to volatility and cannot just ride out a
storm. This is a day trading feature and not something for the long term
investor.

If you have a crystal ball and know that you'll have more up days than down
days, then you are good. Otherwise it is akin to speculating rather than
investing.

They are probably good for a late stage boom cycle (if you could time the
bust).

(Based on the Leveraged ETF's I have found)

------
PhantomGremlin
Existing leveraged ETFs are a scam, designed only to fleece "muppets" (as a
Goldman Sachs guy once called us).

Here's a real life example. You can buy a financial instrument that purports
to hold gold bars on your behalf. Its symbol is GLD. In the past year GLD
price has moved from roughly $123 to $153, more or less equal to the price
change in 0.1 oz of gold.

But that movement isn't enough for some people. They want leverage. So two
leveraged instruments were invented. Cleverly named NUGT and DUST. Purported
to achieve 2x moves in Bullish and Bearish gold directions, respectively.

But let's look at NUGT price from 1 year ago to now. $20.75 -> $7.72.

DUST is even worse. $17.33 -> $2.56.

A lot of this under-performance is because of the friction involved in
leveraged ETFs borrowing and using futures. (This has been explained in great
detail by others, I won't attempt it).

Summary: GLD (the commodity) 24% gain, NUGT 63% loss, DUST 85% loss.

Yes yes, the purveyors of NUGT and DUST will tell you that they're not meant
to be held for 1 year. They're for very short term. But they're just trying to
mislead you. The fact that both directions lost so much money means that these
products do nothing but scam muppets.

The SEC should never have allowed ETFs like that.

~~~
smabie
Hi, I wrote the post. I'm wondering exactly what your issue is with leveraged
ETFs? What, mathematically, makes them unsound? I think my post covers the
risks and benefits of them while also proposing a new kind of leveraged ETF
that might help mitigate the volatility drag associated with leverage.

Edit: I'm not familiar with the leveraged gold ETFs you mention, but I am
familiar with UGLD, which tracks the 3x daily return of gold. Comparing UGLD
vs GLD:

[https://www.google.com/search?client=firefox-b-1-d&tbm=fin&s...](https://www.google.com/search?client=firefox-b-1-d&tbm=fin&sxsrf=ALeKk00j4-E-gQA5dxmzjSRZx_SB9q3wIw:1586139494836&q=NASDAQ:+UGLD&stick=H4sIAAAAAAAAAONgecRoxi3w8sc9YSndSWtOXmNU5-IKzsgvd80rySypFJLkYoOy-
KV4ubj10_UNU8oMM5Irs3gWsfL4OQa7OAZaKYS6-7gAAGxIYxJKAAAA&sa=X&ved=2ahUKEwiWo52J3tLoAhVJmnIEHehlCwQQ3ecFMAB6BAgPEBM&biw=1517&bih=891#smids=/g/11bbrnsz0j&wptab=COMPARE)

UGLD is up compared to GLD. Moreover, UGLD is correctly tracking the 3x daily
move of GLD.

Also, the use of futures and leverage aren't really related. Sure, that's how
most leveraged ETFs work, but there's no reason why there couldn't be a
leveraged ETF that simply borrowed the money.

Edit2: both DUST and NUGT are based on the Gold Miners Index, which isn't the
same as GLD (which tracks actual gold).

~~~
PhantomGremlin
My issue with leveraged ETFs is, quite simply, the 30,000 foot view of
results: They suck.

Even though NUGT and DUST are from the same fund company and purport to do the
opposite of each other, they both lost substantial amounts of muppet money
over the last year!!!

You're trying to analyze these things mathematically, I'm just saying "look at
the actual results over a years time".

I suspect (without checking in detail) that UGLD is doing better is because
it's an ETN and not an ETF. Usually an ETN is a debt obligation of a financial
counter-party, in this case Credit Suisse.

How Credit Suisse manages their debt agreement (the ETN) is up to them. These
can be black boxes to the outside world. It's possible that CS is buying or
selling physical gold or gold futures to hedge their exposure, but they don't
have to be. It's simply a financial contract.

Right now CS is a good financial risk. But the same might have been said about
Lehman Brothers before the great recession. They were counter-parties to some
ETNs and people who owned those were screwed when Lehman went bust:
[https://www.etf.com/sections/features-and-news/lehman-
bros-e...](https://www.etf.com/sections/features-and-news/lehman-bros-etn-
fallout)

I agree with you that a leveraged ETF they can simply borrow money to increase
leverage. (Not much different from how leveraged hedge funds operate). But for
some reason they don't operate that way. So it must be somehow advantageous
for them to use futures. Maybe because it's difficult to "short" something
like e.g. WTI crude in a standardized way on an exchange? You can be long or
short a futures contract for gold or WTI, that's a liquid market. But shorting
the physical commodity might be harder?

------
ridruejo
“ This strategy also greatly reduces the risk of ruin, as the S&P 500 would
need to lose at least 1/3 of its total value in a single day for the fund to
be wiped out. Though certainly imaginable, this event is unlikely as the
biggest single day loss in the history of the S&P 500 was Black Monday in
1987, in which around 20% of value evaporated from the S&P 500 in a single
day.”

That didn’t age well (article is from last October)

~~~
qeternity
How? The recent losses were nothing compared to Black Monday, especially after
a massive 2019.

~~~
dmurray
It dropped 12% on one day in March, not as big as the 20% on Black Monday but
not "nothing". And the bull market of 2019 isn't really relevant when the
article focuses on ETFs that leverage single-day moves.

------
raincom
Your analysis kind of matches with Kelly's betting. 3 times is the optimal:
[https://seekingalpha.com/article/4230171-how-to-apply-
card-c...](https://seekingalpha.com/article/4230171-how-to-apply-card-
counting-strategies-to-etf-portfolios)

------
keanzu
Three questions:

What is the cost of the leverage and how does that affect returns

What is the friction cost of all the trades needed?

Where is part 2?

------
nlitened
Wow, I couldn't even get myself to finish reading this article. This is based
on a very dangerous, ignorant understanding of how markets work. Whatever
"advice" there is, please ignore it.

~~~
mpoon
Could you expand a bit further on what you think the OP's misunderstanding of
the market is?

~~~
nlitened
One huge example is an assumption that portfolio returns are normally
distributed. That’s not a minor nitpick, this invalidates every formula that
goes after.

~~~
jannotti
Well, you did say you didn't finish it. So would it surprise you to learn that
topic is addressed directly?

~~~
nlitened
Thats a fair assumption. But I did skim to the part that attempted to address
non-normality—it doesn’t. Under non-normality, not a single formula in this
post holds (“standard deviation” does not exist).

