Finance Mags, I need some explaining on ETFs???

[liv2ski]

Thanks for stopping in. Question is, when you look at disclosure on 200X ETF's they always say something to the effect of, "this product is for day trading and investors that hold it long term will not get the same results as those that trade it daily". I may be ok with that, but I want your opinion on my thought process. Looking at this chart:



Assuming the chart is above. Lets say the market does the opposite of what we see here and I buy 2000 shares at $50. If the share value eventually goes to $200, would I not have 2000 shares at $200? I am having a hard time figuring out where the issue is?

Thanks for pointing me in the right direction or for taking the time to explain this process to me. Last tank around I just used a simple inverse S&P 500 and I was happy with the results, but if I could double the return with an inverse 200X, so much the better.
Thanks

[4matic]

Issue is because it is 2x it resets the baseline to zero every day.

http://seekingalpha.com/article/1483...to-deteriorate

First of all, these are extremely risky, and investors shouldn't hold on to any leveraged ETF(s) for the "long run", they are almost sure to lose money. These instruments are ideal for traders not investors!

Second of all, let's identify what a leveraged ETF does. A double leveraged ETF uses 200% (triple uses 300%) leverage to capture a specific basket, sector, or index move. Let's take the very popular SDS, which is a 2X inverse tracking the S&P 500; for every 1% move up in the S&P 500 index, SDS will move down by 2%, and for every 1% move down in the index, SDS will move up by 2%. Similarly is the SSO, which is the 2X tracking the S&P 500; for every 1% move up in the S&P 500 index, SSO will move up by 2%, and for every 1% move down in the index, SSO will move down by 2%.

If you're the person who says "It's a great way to hedge my portfolio, so what's the problem with them?", then clear all your other thoughts and read this post carefully - it may save you some money.

It's basic math that so many people overlook! Let's use the benchmark S&P 500 index for an example. Let's say we start off on the S&P 500 at 1000 and a double and triple leveraged ETF both at $100 per. If the benchmark index moves down 10% in 1 week to 900, and assuming both ETFs track perfectly it would put the double leveraged ETF at $80 per share, and the triple leveraged ETF at $70 per share.

Here is where some investors don't use those basic math skills they learned so many years ago, and assume that when the S&P gets back to 1000, the leveraged ETF will trade at the identical value as before, when the S&P was at 1000... THIS IS FALSE!

Basic math tells us this is impossible. In order for the benchmark to get back to 1000 it will need to go up by 11.11% which will correlate to a 22.22% and 33.33% move in the double and triple ETFs respectively.

As we can see, in order to get the double leveraged ETF back to 100 from 80, the benchmark will need to increase by 12.5% correlating to a 25% increase in the double ETF. The triple leveraged ETF will need an even greater move to get back to 100. In order for the triple ETF to get back to 100 from 70, the benchmark will need to increase by 14.283% correlating to a 42.85% increase in the triple ETF.
If the basis index went in a straight line down without any counter trend days then you would get the full value of the incremental 2x change. You have whatever the value is but the value will be skewed whenever you have an up day. So, if you are going to sleep on it then 1X or futures is a better choice.

OBTW: I bought small cap stocks today. Correction due to margin liquidation is largely over imo. Declines have been mostly limited to 5% the last two years. Although I believe the rotation will be to large cap dividend I've been too underweight the small cap sector. Looking to add more long stock over the next 2-3 months.

[Kim Jong-un]

Last tank around I just used a simple inverse S&P 500 and I was happy with the results, but if I could double the return with an inverse 200X, so much the better.
Thanks

You mean a 2X or 3X ETF, not 200X?

If so, unlike long only 1X ETF's which actually purchase the underlying equities to create the ETF, an inverse or 2X/3X ETF is comprised of 100% synthetics (swaps and derivatives). Where the 1X long only will reconcile to NAV at the end of the day by buying and selling the underlying securities, the 2X/3X with synthetics may not. This tracking error gets magnified over time. They are also tax inefficient compared to long only ETF's, since the swaps and derivatives trades are treated as short term capital gains.

Investing in 2X/3X ETF's is the financial equivalent of skiing and avy prone slope after a storm. But then everyone has a different risk tolerance.

[liv2ski]

Issue is because it is 2x it resets the baseline to zero every day.

It's basic math that so many people overlook! Let's use the benchmark S&P 500 index for an example. Let's say we start off on the S&P 500 at 1000 and a double and triple leveraged ETF both at $100 per. If the benchmark index moves down 10% in 1 week to 900, and assuming both ETFs track perfectly it would put the double leveraged ETF at $80 per share, and the triple leveraged ETF at $70 per share.

Here is where some investors don't use those basic math skills they learned so many years ago, and assume that when the S&P gets back to 1000, the leveraged ETF will trade at the identical value as before, when the S&P was at 1000... THIS IS FALSE!

Basic math tells us this is impossible. In order for the benchmark to get back to 1000 it will need to go up by 11.11% which will correlate to a 22.22% and 33.33% move in the double and triple ETFs respectively.

As we can see, in order to get the double leveraged ETF back to 100 from 80, the benchmark will need to increase by 12.5% correlating to a 25% increase in the double ETF. The triple leveraged ETF will need an even greater move to get back to 100. In order for the triple ETF to get back to 100 from 70, the benchmark will need to increase by 14.283% correlating to a 42.85% increase in the triple ETF.
If the basis index went in a straight line down without any counter trend days then you would get the full value of the incremental 2x change. You have whatever the value is but the value will be skewed whenever you have an up day.

So, if you are going to sleep on it then 1X or futures is a better choice.

Thanks for that 4matic. I was aware of everything you said. I guess what I am trying to be sure I get, is going back to the chart and taking into account all you said, the chart would appear to show (in reverse) that at some point a share of this index could go from $50 to $200.

Over the same time period a non leveraged chart (below) goes from about $30 to $60 per share price (when looked at in reverse)



So I am assuming both charts are showing what 1 share was worth at any point in time. Looking at the two charts, am I wrong to conclude that over the same period of time (say 1 year) the leveraged index would have beat the non leveraged account if you had just held both for the same period? Or is the leveraged chart somehow misleading me?

[retirwntm]

liv2ski,

plenty of good info above. if you want more about ETF's ask, but the cheat sheet on ETF's is that they are trading vehicles - to be used with eyes wide open as to their underlying pools and leverage and used strategically when you are either being aggressive with a strategy very short term (<1 day) or trying to get a unique exposure scenario you could not get yourself otherwise, so are willing to pay the ETF creators the premium - while still being able to make more to cover that cost plus.

ETF's are HORRIBLE - I CAN'T SAY THAT EMPHATICALLY ENOUGH for positioning OVER ANY TERM > REBALANCE (1 day). there are many white papers, etc. that explain why this is the case, 4matic's link explains the math differently, but the point is similar.

i feel like suggesting options over ETF's is like trading you a sniper's rifle for a shotgun. they are still both dangerous, but the rifle is the right tool for what you are asking. options may seem more esoteric, but can be much more the product you're looking for over a longer period if you are taking a genuine position. again - options on an established product like the S&P, not ETF options - this is worse than the leveraged ETF's.

[liv2ski]

You mean a 2X or 3X ETF, not 200X?

If so, unlike long only 1X ETF's which actually purchase the underlying equities to create the ETF, an inverse or 2X/3X ETF is comprised of 100% synthetics (swaps and derivatives). Where the 1X long only will reconcile to NAV at the end of the day by buying and selling the underlying securities, the 2X/3X with synthetics may not. This tracking error gets magnified over time. They are also tax inefficient compared to long only ETF's, since the swaps and derivatives trades are treated as short term capital gains.

Investing in 2X/3X ETF's is the financial equivalent of skiing and avy prone slope after a storm. But then everyone has a different risk tolerance.

I like your analogy. I would be primarily trading a IRA acct, so taxes are not an issue. Yes, it is 2X or 3X, put the prospectus show them at 200% & 300%. Perhaps the key here is your comment; "Where the 1X long only will reconcile to NAV at the end of the day by buying and selling the underlying securities, the 2X/3X with synthetics may not. This tracking error gets magnified over time".

Still, if you look at the two charts in reverse over the same period of time, would not an investment in each ETF have a share value shown on the charts?

[liv2ski]

OK, now I see it as I just looked at the link 4matic gave me. In the article was a 1 year trading example http://walllstreeet.com/Double%20and...readsheet.xlsx
That pretty much shows you the math in a down market and sold me that the leveraged ETF is a bad idea. That said, I am uncertain I can buy options with an IRA account. I have sold options on covered calls, but I am a total jong when it comes to buying them, so I will do some homework.
I appreciate the help.

[4matic]

If you want leverage trade futures. They have the leverage you want (around 10x1), no duration risk, low fees, and a tax advantage. I doubt you can trade them in your current IRA though. Futures are not riskier than 3x etf's if you manage your risk. jmo.

Margin on Russell 2000 e-mini is $3500.

[4matic]

OK, now I see it as I just looked at the link 4matic gave me. In the article was a 1 year trading example http://walllstreeet.com/Double%20and...readsheet.xlsx
That pretty much shows you the math in a down market and sold me that the leveraged ETF is a bad idea. That said, I am uncertain I can buy options with an IRA account. I have sold options on covered calls, but I am a total jong when it comes to buying them, so I will do some homework.
I appreciate the help.

Options: Sellers make money. There is some serious math going on with option trading and they are best used to hedge risk. Nothing worse than being right and wrong at the same time which is pretty common with options. If you do want to position with options and your time frame is months look at LEAPS.

[retirwntm]

no duration risk

this wording does not sit right with my FI background. what you mean is that you can enter a futures contract at any point, and close said contract as well - correct? implying there is no risk of being locked in to any contract for any period (duration) at which you cannot control?

to me, there is no other duration risk in finance than this:

http://www.investopedia.com/universi...ancedbond5.asp

[Kim Jong-un]

liv2ski, you need a margin account to trade options or short stocks. Your IRA is a long only cash acct. You will not be able to trade options in it.

Again, risk tolerance is different for everyone, but I would also advise that you use options only to hedge long or short positions. You need to get both the price direction and the date correct on options. On straight up longs and shorts you only need to get price direction right. I'll let you determine which is harder.

If liv2ski wants $2retire, and depending on your time horizon for that, I would suggest a low load S&P500 Index fund. Unless you have the time and desire to spend your days learning to trade and analyze equities, you will likely be better off.

[4matic]

this wording does not sit right with my FI background. what you mean is that you can enter a futures contract at any point, and close said contract as well - correct? implying there is no risk of being locked in to any contract for any period (duration) at which you cannot control?

to me, there is no other duration risk in finance than this:

http://www.investopedia.com/universi...ancedbond5.asp

I meant time and structural risk like options and leveraged ETF's. Duration was the only word I could think of.

You need a margin account to trade options or short stocks. Your IRA is a long only cash acct. You will not be able to trade options in it.

Again, risk tolerance is different for everyone, but I would also advise that you use options only to hedge long or short positions. You need to get both the price direction and the date correct on options. On straight up longs and shorts you only need to get price direction right. I'll let you determine which is harder.

You can trade options and futures in an IRA if it is setup with the right brokerage. From Interactive Brokers:

What can I Invest in?
Stocks, covered call writing (covered shares are restricted), buying calls (funds equal to the aggregate exercise value of the long calls are restricted), and buying puts (shares subject to exercise are restricted), selling cash secured puts, spreads securities with European style expiration, futures contracts, and futures options. The IB IRA is structured as a Stock Cash Account (if you choose to trade only stocks) or as a Stock Options Level I Account (if you choose to trade options in your IRA). IRAs may also invest in US dollar denominated futures contracts, and future option contracts.

[Kim Jong-un]

You can trade options and futures in an IRA if it is setup with the right brokerage.

I stand corrected. Not familiar with these guys and the Scotttrades of the industry. Many of the big investment firms will not let you do this as they don't want to deal with monitoring the cash collateral balances.

[liv2ski]

I am with Optionsxpress as I have done covered call trading for a few years. I confirmed I can do options with my IRA. I spent the last 4 hours reading up on them and now have enough knowledge to be dangerous to myself. I will do a lot more reading and follow up on Futures too.
Thanks for the input guys.

[thin cover]

you buy etfs from 9:30 to 10:30 on a 1 or 2 min chart and thats its, or even premarket. DO NOT INVEST LONG TERM IN THESE. I could say more but its all been said. Great for high volume scalp trading.

[liv2ski]

you buy etfs from 9:30 to 10:30 on a 1 or 2 min chart and thats its, or even premarket. DO NOT INVEST LONG TERM IN THESE. I could say more but its all been said. Great for high volume scalp trading.

TC, thanks for the food for thought, but after reading http://www.ubscure.com/Art/149786/21...p-Trading.html I really don't think scalp trading is what I am looking for. I will keep reading and see where it takes me. Thanks for your 2 cents

[dirtybryan]

Sorry for the threadjacking, but any recommendations about resources to learn about investing? Looking to invest a little bit of money to learn the ropes, but obviously would prefer not to learn the hard way.

[Like a Boss]

you buy etfs from 9:30 to 10:30 on a 1 or 2 min chart and thats its, or even premarket. DO NOT INVEST LONG TERM IN THESE. I could say more but its all been said. Great for high volume scalp trading.

liv2ski,

plenty of good info above. if you want more about ETF's ask, but the cheat sheet on ETF's is that they are trading vehicles - to be used with eyes wide open as to their underlying pools and leverage and used strategically when you are either being aggressive with a strategy very short term (<1 day) or trying to get a unique exposure scenario you could not get yourself otherwise, so are willing to pay the ETF creators the premium - while still being able to make more to cover that cost plus.

ETF's are HORRIBLE - I CAN'T SAY THAT EMPHATICALLY ENOUGH for positioning OVER ANY TERM > REBALANCE (1 day). there are many white papers, etc. that explain why this is the case, 4matic's link explains the math differently, but the point is similar.

Just to clarify, you guys are talking about leveraged and inverse ETFs here, correct? Or does your hate extend to regular ETFs (SPY, ACWI) for general long term investing?

[liv2ski]

Just to clarify, you guys are talking about leveraged and inverse ETFs here, correct? Or does your hate extend to regular ETFs (SPY, ACWI) for general long term investing?

Regular ETFs like a mutual fund are not leveraged, so are appropriate for a longer term investment. I like to day trade some leveraged ETFs, but it has been clearly pointed out to me that I am in and then out.

[retirwntm]

Options: Sellers make money.

you must see the flaw in your premise here, btw. otherwise, liv2ski should be selling options hand over fist and take you heli-skiing at a minimum for the tip.

Like a Boss - 2nd part of what i said about ETF's is where i would place unlevered ETF's - as long as i think the value is worth it, i am ok with it, but you are paying a premium above, say, a fund (morningstar, vanguard, etc.) and the only advantage in the case you mention of an S&P500 basket is that you can trade in and out at any point during regular trading hours like a regular stock. is it worth the premium over a fund? your call...

[thin cover]

Just to clarify, you guys are talking about leveraged and inverse ETFs here, correct?

yes 1234

[Kim Jong-un]

Sorry for the threadjacking, but any recommendations about resources to learn about investing? Looking to invest a little bit of money to learn the ropes, but obviously would prefer not to learn the hard way.

Unfortunately, there is only the hard way. By that I don't mean "the hard way"="losing money"
but you need to spend some serious time reading. Start reading the most recent iteration of Benjamin Grahams book "Security Analysis," which was actually first written in 1934 after the first big crash. Its still very relevant today. After you've primed yourself with that, and wiped the sleep out of your eyes, start reading 10Q's and 10K's that companies publish. Then make some trades (start with plain vanilla long trades)if you like the company from what you read. In keeping with the spirit of this site, if you want to start reading something germaine to the ski industry, Black Diamond (Ticker: BDE) is a public company. Not recommending it, just saying it may be a more fun 10Q/K to read than say, Clorox. Remember, the only edge you have over a professional investor is patience (they have to make quarterly numbers), and the ability to invest in smaller companies than they can. Have fun!

[4matic]

you must see the flaw in your premise here, btw. otherwise, liv2ski should be selling options hand over fist and take you heli-skiing at a minimum for the tip.
.

Only a minor flaw:


"While there are certainly many viable options-buying strategies available to traders, options expiration data obtained from the CME covering a three-year period suggests that 3 Based on data obtained from the CME, I analyzed five major CME option markets - the S&P 500, eurodollars, Japanese yen, live cattle and Nasdaq 100 - and discovered that three out of every four options expired worthless. In fact, of put options alone, 82.6% expired worthless for these five markets.

Three key patterns emerge from this study: (1) on average, three out of every four options held to expiration end up worthless; (2) the share of puts and calls that expired worthless is influenced by the primary trend of the underlying; and (3) option sellers still come out ahead even when the seller is going against the trend.

Conclusion
Data presented in this study comes from a three-year report conducted by the CME of all options on futures traded on the exchange. While not the entire story, the data suggests overall that option sellers have an advantage in the form of a bias towards options expiring out of the money (worthless). We show that if the option seller is trading with the trend of the underlying, this advantage increases substantially. Yet if the seller is wrong about the trend, this does not dramatically change the probability of success. On the whole, the buyer, therefore, appears to face a decided disadvantage relative to the seller.

http://www.investopedia.com/articles.../03/100103.asp

[enzo3366]

Dumb but Semi-Related ETF question: what about if the trend you want to capture is pronounced and lengthy? Say if you think a commodity's price will drop quite a bit over the next few months, but don't want to deal with the time dimension of options, would a leveraged ETF be a good instrument to hold for more than a day? I realize that the % change of the ETF won't be the same as the % change of the underlying commodity. However if the we're talking about a substantial portion more of down days than up, would the leveraged ETF be a good hold over more than a day?

I'm looking at DTO, specifically, but hoping to broaden it to any commodity where a sizable correction seems imminent. Was a complete noob (learning) when I held a small amount of DTO between Aug 08 and Feb 09. The more I read, the more I think it was just dumb luck. However if I don't want to deal with the time dimension of options, is there a better way of going about it while still getting the exposure I want? Haven't really found anything in my reading without going to options.

[4matic]

Dumb but Semi-Related ETF question: what about if the trend you want to capture is pronounced and lengthy? Say if you think a commodity's price will drop quite a bit over the next few months, but don't want to deal with the time dimension of options, would a leveraged ETF be a good instrument to hold for more than a day? I realize that the % change of the ETF won't be the same as the % change of the underlying commodity. However if the we're talking about a substantial portion more of down days than up, would the leveraged ETF be a good hold over more than a day?

I'm looking at DTO, specifically, but hoping to broaden it to any commodity where a sizable correction seems imminent. Was a complete noob (learning) when I held a small amount of DTO between Aug 08 and Feb 09. The more I read, the more I think it was just dumb luck. However if I don't want to deal with the time dimension of options, is there a better way of going about it while still getting the exposure I want? Haven't really found anything in my reading without going to options.

You can hold a leveraged ETF intermediate term in a strong trend and it will work. You just have to have rules to define your trend.

Futures are the cleanest way but you have to be very good at managing risk to trade futures because you typically will have 10-1 or more leverage.