Leveraged ETFs

While that may be true of intraday scalpers or even contrarian traders, it's not the siren's call of all traders, especially those dipping their toes in the leveraged ETF game. This is a segment of the market I covered well before most. In fact, the introduction of leveraged ETFs and the controversy around them was the entire reason I began writing for Real Money. It's been more than a decade since I begin explaining the proper uses, misuses, risks, rewards, misunderstandings, and possible strategies around ETFs. I've even managed to convert a few folks here to join in the explanation of the risks.

The biggest challenge is we're often using theoretical numbers to really drive home the point. It often went something like this:

1. Day 1 - the index climbs X%
2. Day 2 - the index falls (1.5)X%
3. Day 3 - the index rises Y%
4. Day 4 - the index falls (1.5)Y%

Then, we compare what kind of market move you need to get back to breakeven. It's a valid and practical exercise, but it can easily be brushed aside. People review it and think markets don't move with that kind of oscillation or symmetry. We've been spoiled with trends the past decade. And leveraged ETFs love trends. They reward them handsomely when you are correct on the trend, and actually punish you less when you're wrong.



But volatility... well, that's a different story.

This year has been chalked full of volatility, so I thought it might be an opportune time to check out the impacts of what I call "Volatility Decay" on leveraged ETFs. This is the impact of the ETFs needing to reset their leverage to the market each night after the close, so it can be accurate for the next day's move/change. Unfortunately, this results in a repeated process of buying higher highs and selling lower lows. That's not a recipe for long-term success.

Let's take a vision look over the past 7, 30, and 90 days at the SPDR and its 3x leveraged counterparts on both the bullish and bearish side. I should note, these ETFs are not broken. They act very closely upon what they are intended to do. What's generally broken is the understanding of the product. They are DAILY products, not weekly, monthly, or quarterly.

Over the past week measured in trading days and not including today, the (SPY) (S&P 500) fell 2.9%. Three times that number is 8.7%, but you can see the impact the daily resets have on performance as the 3x long (ProSh UltPro S&P 500) fell 10.85% while the 3x short (PS UltPro Sh S&P 500) rose only 4.46%.