Author Topic: 3x REIT's or 3x S&P  (Read 3940 times)

tsukuba

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3x REIT's or 3x S&P
« on: December 26, 2016, 02:20:45 AM »
Hi, is anybody out there liking or disliking the 3x REITs or 3x Standard & Poor's ETF, tickers DRN and SPXL (or UPRO), respectively.  If you're in it for the long term, they absolutely blow away their respective unleveraged indexes. The trading volume in DRN has significantly gone down since it came out in 2009. There must be a reason but it's not clear. Thanks.

arebelspy

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Re: 3x REIT's or 3x S&P
« Reply #1 on: December 26, 2016, 02:34:57 AM »
If you're in it for the long term, they absolutely blow away their respective unleveraged indexes.

No.

They are the opposite of a long term play--they lose due to decay. They should be used for day trading only (i.e. held, and sold, for under a day), which most of us here don't do.

Buying a normal fund with leverage (margin) can make sense in rare circumstances, if you want to dial up the risk.  The pre-leveraged ones that just erode value due to decay never make sense to hold long term.

I googled and picked a few random articles for you to read if you're not familiar with the concept of decay that makes these terrible to hold for longer than a day.

This article has an example of a market being flat over a week, and both a leveraged long AND a leveraged short losing money (rather than being flat, if they tracked perfectly):
https://dqydj.com/dont-use-leveraged-etfs-unless/



The normal fund starts and ends at $1000 (a 0% change).  The long ends at ~$932 (a 6.8% loss), the short ends at $749 (a 25.1% loss).

Here's a few more explanation articles to wrap your head around it:
http://etfdb.com/leveraged-etfs/leveraged-decay-the-dangers-of-long-term-investing-with-etfs/

https://rightsideofthechart.com/leveraged-etf-price-decay-explained/

Run from these, don't walk.
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gerardc

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Re: 3x REIT's or 3x S&P
« Reply #2 on: December 26, 2016, 03:51:52 AM »
Here's my intuitive understanding of decay:

When you use leverage, there's always the risk of margin calls (when your net value becomes close to 0). If you can bear with a dip without triggering them and recover, you can then benefit from a multiplied average return; if not, you lose everything. Volatility influences the probability of margin calls, so what really matters for an investment is the ratio of average return to variance (see Sharpe ratio) because you can always leverage investments with the same Sharpe ratio to get the same return for the same risk of losing everything, roughly.

Now, there's a simple way to avoid margin calls: periodically "rebalance" your leverage to a set value, i.e. if the  share value has gone down after a set time period, repay some debt, and if it has gone up, get more debt, so that your leverage stays on target. The more frequently you "rebalance", the less margin call risk you have. If you rebalance continuously every second, you have virtually 0 risk, assuming perfect liquidity. If you rebalance every month, then you need the dips to go up quickly enough without triggering the margin calls. Most leveraged ETFs will rebalance once a day, eliminating most of the margin-call risk* at the expense of efficiency.

Rebalancing frequently is the safest, but also the least efficient. The reason is if there are market fluctuations, and you rebalance once in a peak or a dip, then after a return to normal, you lose. This is because rebalancing in a low will reduce your leverage right before the increase; rebalancing in a high will increase your leverage right before the decrease; both are bad. Another way to see it is that rebalancing frequently will cause you to sell low and buy high, which is the opposite of what you want. The more fluctuations you capture, the more you'll lose. If there are ups and downs every second and you rebalance continuously, you'll lose big very fast.

The only strategy if you're going to make leverage work is to leverage and hold, and pray for no margin calls. When there's a dip, holding your loans will automatically increase your leverage, so that a future market recovery will put you exactly where you started. A dip puts you in a more vulnerable position, making you "double down" on your bet: either recover, or lose everything. You can rebalance after a few months if the market went up, i.e. buy more shares.

I'd never leverage the S&P 500 with more than 20% (1.2x). If you use 2x, you basically assume that the market always recovers above 50% (i.e. it never dips below 50% of any past value) which isn't true historically. If you use 3x, you assume the market never dips below 66.7%, etc. At 1.2x, you assume it never dips below 16.7% of any past value, which I think is true historically. At no leverage, you have no risk of margin calls, so in theory you can keep your shares forever and always hope for a rebound, although some shares do lose all value sometimes.

*Who knows what happens to the 3x ETFs in a single day at -33.3%? Shit must hit the fan in many ways anyway, but that's a possibility. They'll probably sell a little before they hit the margin call, call it a day, set the fund value to 0, and close it.
« Last Edit: December 26, 2016, 03:57:19 AM by gerardc »

arebelspy

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Re: 3x REIT's or 3x S&P
« Reply #3 on: December 26, 2016, 03:59:04 AM »
That is not what decay is at all.

Margin calls have nothing to do with decay.
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pbkmaine

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Re: 3x REIT's or 3x S&P
« Reply #4 on: December 26, 2016, 04:03:50 AM »

UnleashHell

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Re: 3x REIT's or 3x S&P
« Reply #5 on: December 26, 2016, 04:22:31 AM »
My favorite leverage story:

https://en.m.wikipedia.org/wiki/Long-Term_Capital_Management

25 to 1 debt equity ratio. for gambling.
nice work people. smart!

gerardc

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Re: 3x REIT's or 3x S&P
« Reply #6 on: December 26, 2016, 04:25:27 AM »
Margin calls have nothing to do with decay.

Rebalancing leverage ratio to avoid margin calls fundamentally leads to decay.

Explained in my post above. What don't you agree with?

protostache

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Re: 3x REIT's or 3x S&P
« Reply #7 on: December 26, 2016, 10:56:15 AM »
Margin calls have nothing to do with decay.

Rebalancing leverage ratio to avoid margin calls fundamentally leads to decay.

Explained in my post above. What don't you agree with?

Leveraged ETFs and ETNs reset *daily* to match their index. They don't do it to avoid margin calls, as far as I understand.

gerardc

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Re: 3x REIT's or 3x S&P
« Reply #8 on: December 26, 2016, 12:41:37 PM »
Margin calls have nothing to do with decay.

Rebalancing leverage ratio to avoid margin calls fundamentally leads to decay.

Explained in my post above. What don't you agree with?

Leveraged ETFs and ETNs reset *daily* to match their index. They don't do it to avoid margin calls, as far as I understand.

Right, they don't really have a choice to rebalance daily in order to provide a "share price" and let different investors buy in at any time, but this has also the consequence of severely reducing the probability of margin calls, and also leads to decay. Notice how buy-and-hold DIY 3x leverage has a significant probability of margin call over time, but 3x leveraged ETF margin call probability is much lower, since it resets every day.

In summary, margin-call risk and decay are fundamentally interrelated in high-volatility markets. The trade-off is set based on rebalancing frequency.

tsukuba

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Re: 3x REIT's or 3x S&P
« Reply #9 on: December 26, 2016, 11:33:02 PM »
Thank you very much for your feedback.
It looks like Proshares 2x QQQ (QLD) could survive the 2007-2009 downturn.  I suppose a 3x leveraged vehicle would have wiped out during that period.

I can understand there is decay and drag caused by leverage.  The prospectus section on risks here goes through it all pretty well, with examples in some cases.

http://direxioninvestments.onlineprospectus.net/DirexionInvestments//DRN/index.html?open=Summary%20Prospectus

Based on the VNQ, the REIT that DRN leverages, it seems that indeed DRN would have likely wiped out in the 2007-2009 downturn.  So yes, I see it requires caution.

Best wishes-



arebelspy

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Re: 3x REIT's or 3x S&P
« Reply #10 on: December 27, 2016, 12:04:44 AM »
If you are talking about a wipeout during a down turn, you are not understanding decay.  Read the linked articles.
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tsukuba

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Re: 3x REIT's or 3x S&P
« Reply #11 on: December 27, 2016, 02:02:42 AM »
arebelspy, thank you for educating and emphasizing the matter of decay.  It is an important consideration, however, as I look at the performance of the 2x or 3x leveraged ETFs, severe market downturns seem to be the bigger concern.   
« Last Edit: December 27, 2016, 02:08:01 AM by tsukuba »

protostache

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Re: 3x REIT's or 3x S&P
« Reply #12 on: December 27, 2016, 05:43:32 AM »
arebelspy, thank you for educating and emphasizing the matter of decay.  It is an important consideration, however, as I look at the performance of the 2x or 3x leveraged ETFs, severe market downturns seem to be the bigger concern.

My personal opinion is that leveraged ETFs and ETNs are too hard. Why bother adding this kind of risk when I can just buy shares of ordinarily risky companies, either directly or through a plain index fund or ETF? If lots of people are telling me there are dragons somewhere I tend to avoid that place.

jim555

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Re: 3x REIT's or 3x S&P
« Reply #13 on: December 27, 2016, 05:57:08 AM »
I would short the long and short 3X funds together.  Is that possible?

arebelspy

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Re: 3x REIT's or 3x S&P
« Reply #14 on: December 27, 2016, 06:13:48 AM »
I would short the long and short 3X funds together.  Is that possible?

Can't find a place to borrow them from.  Otherwise yes, decay would then make you very rich over time.
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Huskie87

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Re: 3x REIT's or 3x S&P
« Reply #15 on: December 27, 2016, 01:59:56 PM »
Yup, terrible things to mess with.  Just like VXX.  No educated investor would ever invest in these products with more than a single day timeframe, and more likely a timeframe of just a few hours or minutes.


Financial.Velociraptor

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Re: 3x REIT's or 3x S&P
« Reply #16 on: December 27, 2016, 03:26:31 PM »
I would short the long and short 3X funds together.  Is that possible?

Can't find a place to borrow them from.  Otherwise yes, decay would then make you very rich over time.

I have good success with shorting UVXY via options.  Like ARS said, shorting the underlying is problematic.  I always got knocked out of the trade at the worst time and paid punitive borrowing fees.  Options are the way go.

tsukuba

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Re: 3x REIT's or 3x S&P
« Reply #17 on: December 27, 2016, 11:14:05 PM »
I would short the long and short 3X funds together.  Is that possible?

Can't find a place to borrow them from.  Otherwise yes, decay would then make you very rich over time.

I have good success with shorting UVXY via options.  ....  Options are the way go.

That is indeed interesting.

trollwithamustache

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Re: 3x REIT's or 3x S&P
« Reply #18 on: December 28, 2016, 08:57:56 AM »
I would short the long and short 3X funds together.  Is that possible?

Can't find a place to borrow them from.  Otherwise yes, decay would then make you very rich over time.

The shares can become available on Interactive Brokers via their stock borrow/loan tool. But, the short interest rates can be a bit high.  In general I like the idea of shorting these leveraged ETFs but the fees/cost of the trade is a very real consideration that has always led me to passing on actually doing it. 

And of course, practice safe position sizing. :)