Tuesday, March 03, 2009

ETF Leverage - Test Case

As we discussed before, leveraged ETFs decay in trendless markets. Against the negative of decay is the positive of some hyper-compounding when the underlying moves in one direction for several days in a row.

Consider the S&P 500 - It has fallen in 11 out of the past 12 days. Here's its price action alongside the SDS, its double short ETF.

So from February 12th's close to today, the S&P 500 index has fallen:

(835.19 - 696.33) / 835.19 = 16.62%

Therefore minimally, on a discrete one-day fall, the SDS should have appreciated by:

2 * 16.62% = 33.24%

That would bring the SDS up to:

1.3324 * 78.41 = 104.47.

As you can readily see, the SDS today closed at 109.36 so an *11 out of 12-day* dive added about 5 points in leverage.

Is it worth it?

I'm not convinced at all that the decay risk is offset by this bit of increased leverage.

I mean, 11 out of 12 days is too rare, too extreme, to provide so little boost.

Leverage, for this index/ETF anyway, will be better purchased with futures or in the option pits.

After all, if you're really sure a ticker will decline or appreciate for the next several days, then why not just grab some front month option contracts?

Related posts:

ETF Daily Compounding

More On ETF Decay

Measuring ETF Decay

Leveraged ETF Risk


Taylor Conant said...

Where can I learn more about the mechanics of doing just that, buying options?

I need a different way to profit off of this bust.

CaptiousNut said...

There just has to been plenty of stuff online for free. Exhaust that first.

You do have to read the theoretical books. There was one by Natenberg that I read as a 'young coot'.

I remember liking the introductory book by Hull better - and that may serve your purpose - for starters anyway.

After that, I have my *training program* that I wrote 12 years ago somewhere in my file cabinet.

Prince C-Nut is almost ready for it. Get moving so a 4 year old doesn't embarrass your lazy @ss.