Stock Trading - Leveraged ETFs
The Exchange Traded Funds (ETFs) are very good investments rather than a single stock as it contains many stocks in small proportions usually in the same sector. We can trade during market hours unlike mutual funds. However there are some ETFs with so much leverage; We need to be very careful while playing with those funds.
Usually the leveraged ETFs will yield about daily investments results of either 200% or 300% of the price performance of the selected index where as in case of regular ETFs it would be 100%. I have analyzed the unfavorable and worst case scenario for 3 with manually generated 3 weeks of data.
Leveraged ETFs in unfavorable scenario
The following table can explain how different leveraged ETFs can result in case of unfavorable scenarios:
Day |
ETF |
% Change |
ETF 3X leveraged |
% Change |
1 |
100.00 |
0 |
100.00 |
0 |
2 |
101.46 |
1.46% |
104.39 |
4.39% |
3 |
102.94 |
1.45% |
108.93 |
4.35% |
4 |
95.15 |
-7.56% |
84.23 |
-22.68% |
5 |
89.97 |
-5.45% |
70.46 |
-16.35% |
6 |
87.09 |
-3.20% |
63.69 |
-9.60% |
7 |
91.09 |
4.60% |
72.48 |
13.80% |
8 |
100.00 |
9.78% |
93.75 |
29.34% |
9 |
101.20 |
1.20% |
97.12 |
3.60% |
10 |
92.64 |
-8.46% |
72.47 |
-25.38% |
11 |
75.97 |
-18.00% |
33.34 |
-54.00% |
12 |
79.38 |
4.50% |
37.84 |
13.50% |
13 |
84.78 |
6.80% |
45.56 |
20.40% |
14 |
92.80 |
9.46% |
58.49 |
28.38% |
15 |
100.42 |
8.21% |
72.89 |
24.63% |
Day 11 on the above table, regular ETF is down by about 24% from the initial value where as leveraged ETF is down by 66.66%. It may not be a surprise as it is leverage by 300%. When it comes to recovery on Day 15, the regular ETF recovered completely however the leveraged ETF is still down by 27%. Consequently we can consider holding leveraged ETFs as a speculative play and not a long term investment, say 1 year or 2 years.
Leveraged ETFs in worst case scenario
The following table explains the worst case scenario with leveraged ETFs. These situations may not happen frequently but still we can not rule out the possibility of such event.
Day |
ETF |
% Change |
ETF 3X leveraged |
% Change |
1 |
100.00 |
0 |
100.00 |
0 |
2 |
101.46 |
1.46% |
104.39 |
4.39% |
3 |
102.94 |
1.45% |
108.93 |
4.35% |
4 |
95.15 |
-7.56% |
84.23 |
-22.68% |
5 |
89.97 |
-5.45% |
70.46 |
-16.35% |
6 |
87.09 |
-3.20% |
63.69 |
-9.60% |
7 |
91.09 |
4.60% |
72.48 |
13.80% |
8 |
100.00 |
9.78% |
93.75 |
29.34% |
9 |
101.20 |
1.20% |
97.12 |
3.60% |
10 |
68.41 |
-32.40% |
2.72 |
-97.20% |
11 |
69.80 |
2.03% |
2.89 |
6.09% |
12 |
74.55 |
6.80% |
3.47 |
20.40% |
13 |
85.40 |
14.56% |
4.99 |
43.68% |
14 |
96.34 |
12.81% |
6.91 |
38.43% |
15 |
100.78 |
4.60% |
7.86 |
13.80% |
If you look at the Day 11 on the above table, regular ETF is down by about 30% where as leveraged ETF is down by 97%. Even when regular ETFs recovered all the loses, leveraged ETFs has no way of recovering losses and stays down by 92%.
You will get a significant gains in leveraged ETFs however if you have to go through unfavourable or worst case scenario, then losses will be more in percentages. This percentage loss in unfavorable times will outnumber the percentage gain in favorable times.
Be careful when trading leveraged ETFs!
Posted on June 12, 2010
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