Research has shown that leveraged ETF products may not perform nearly as expected in these volatile markets, a quality that proves them as being suited only for very short-term trading.
ProShares states on its Web site:
“Each Short or Ultra ProShares ETF seeks a return that is either 3x, 2x, -1x, -2x or -3x of the return of an index or other benchmark (target) for a single day, as measured from one NAV calculation to the next. Due to the compounding of daily returns, ProShares’ returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period.
These effects may be more pronounced in funds with larger or inverse multiples and in funds with volatile benchmarks. Investors should monitor their ProShares holdings consistent with their strategies, as frequently as daily.”
While I sometimes use those products for short-term trades, I will never hold them for a long time.
Let me explain why.
Imagine you have an asset class with a price today of $100. To keep it simple, let’s also assume that the 2x long ETF also trades at $100 today.
From the table below, you can see that if the asset is going in one direction without a lot of volatility, you may actually gain more on the leveraged ETF than initially expected. While the asset class rose from $100 to $110 (+10%), the leveraged long ETF gained +20.89%, although we expected it to be +20% (two times the percentage gain of the asset class).
This is a favorable situation.
However, imagine we get a situation that works against us. We own a 2x short ETF, and the market keeps rising.
In this case, we are lucky as well, because we will "only" lose ($100-$82.42)/$100=17.58%, while we would expect a loss of -20%.
The two tables above show us that we might get a favorable situation with leveraged ETFs when volatility is very low.
But what happens when volatility is very high, as it has been recently?
Let’s assume again we have an asset class which is priced at $100, and a leveraged short ETF which is also priced at $100 today.
If the volatility is very high, we might end up losing a lot of money, as we can see from the table below. Even though the asset class ended up just where it began (at $100), our 2x short ETF has lost 7.94%!
The same would be true if we have a 2x long ETF: even though the asset class ended up just where it began (at $100), we would have lost money with the leveraged long ETF.
In the chart below, I set the initial value of each at $100, starting at January 1, 2011. The candlestick chart is the silver price, the green line is AGQ, and the purple line is ZSL.
As we can see, silver lost 12.25% this past year, so one would expect to have gained two times 12.25%, or 25.50%, with ZSL this past year then, right?
Wrong! ZSL lost 59.75% in the past year!
See related: Leveraged ETFs: Worst Investment Ever
In addition, one would expect to have lost two times 12.25%, or -25.50%, with AGQ this past year, right?
Wrong again! AGQ lost 46.79% this past year!
It can also happen with the -1x ETFs, even though they do not leverage the price.
While the S&P 500 gained 0.43% since the beginning of the year, SH lost 8.21%!
The correlation may be high, but it’s not perfect.
That’s why you have to mind the leveraged ETF products. They can be used for very short-term trades (usually only a day or two), but don’t buy them to buy and hold unless you expect price to keep going in one direction. Even then, these variations may occur.
See related: The Leveraged ETF Safety Kit
The bottom line: stick to short-term trades in any leveraged ETF!
By Willem Weytjens of Profitimes.com
Mutual Funds & ETFsFind out about the First Trust Dow Jones Global Select Dividend Index Fund, and learn detailed information about characteristics and suitability of the fund.
Mutual Funds & ETFsLearn about the United States 12 Month Natural Gas Fund, an exchange-traded fund that invests in 12-month futures contracts for natural gas.
Mutual Funds & ETFsExplore detailed analysis and information of the iShares Floating Rate Bond ETF, and learn how to use this ETF as a defense against rising interest rates.
Mutual Funds & ETFsFind out information about the ProShares UltraPro Short S&P 500 exchange-traded fund, and learn detailed analysis of its characteristics and suitability.
Mutual Funds & ETFsLearn more about the SPDR Barclays Investment Grade Floating Rate Fund, which tracks an index of highly rated floating debt securities.
Mutual Funds & ETFsLearn more about a unique and innovative exchange-traded fund (ETF) in the biotechnology industry: the ALPS Medical Breakthroughs Fund.
Mutual Funds & ETFsLearn about the iShares U.S. Healthcare exchange-traded fund, which invests in a wide range of health care providers, hospitals and home care facilities.
MarketsRead about the top five Chinese natural gas companies as measured by gas production volume and learn a little more about their business operations.
Mutual Funds & ETFsDiscover five of the most popular and best-performing mutual funds offering investors direct exposure to equities of Japanese companies.
MarketsRead about the top Chinese insurance companies by market capitalization, and learn a little about their positions in the marketplace.
The value of an asset less the value of all liabilities on that ...
A security that tracks an index, a commodity or a basket of assets ...
Investopedia explains the definition of exchange-traded mutual ...
An alternative investment theory to Efficient Market Hypothesis ...
An asset that is extremely difficult to dispose of either due ...
When an investor has essentially risked all of his capital for ...
When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>