Get ready for that triple shot whatever it is you order.Direxion Funds, the kings of levered products, just filed for a bunch of triple long and triple
According to Index Universe the list is as follows;
1) MSCI Broad Market
2) Nasdaq 100
3) Dow Jones Industrial
4) S&P Midcap 400
5) Russell 2000
6) Nikkei 225
7) MSCI EAFE
8) MSCI Emerging Market
9) S&P BRIC 40
10) FTSE/Xinhua China 25
11) Indus India
12) S&P Latin America
13) MSCI Commodity Related Equity
14) Energy Select Sector
15) Financial Select Sector
16) DJ US Real Estate
17) S&P US Home Building Select
As with the double long and double short these will, assuming they actually list and do what they are supposed to, open the door to several different types of strategies ranging from speculative gambling to what is essentially portfolio rocket science.
As with the double products, the Direxion ETFs objective is on a daily basis not over any longer period of time. For an understanding of how this can create surprises for people; over the last 12 months SPY is down 5% but over that same period the double long S&P 500 (SSO) is down 20%. For the calender year 2007 SPY was up 3.5% and SSO was down 3.5%. That doesn't necessarily mean the product doesn't work but somehow the combination of up and down days netted those two results.
I think the long products would give a better longer term result in a market that was trending up as opposed to a market that has been rolling over but that's just an opinion.
Chances are some folks will get very aggressive with these, I would probably only be interested in the triple short S&P 500 or maybe triple short EAFE as a hedge for when the market is below its 200 DMA and some other folks will create some very sophisticated pairings of long/short, single/double/triple, different indexes and so on.
A portfolio using only broad-based products could have neutralized out the financials very efficiently with the triple short financials without disrupting too much of the rest of the portfolio. Unfortunately the rocket science applications of these products don't get written about very often but maybe between now and when these funds list I can dig something up.
While it should go without saying I'll say it anyway levered products used incorrectly offer the risk of an absolute blowup. A position on the wrong side of the trade on a day where the market moves 2% could result in an 8% loss. Check the math? No, the goal would be three times but occasionally it moves more or less than the objective and this sort of scenario on a given day is plausible.
For anyone looking at these as an efficient hedge, trust me, a little bit will go a long way.
The picture is from a coffee house Parua Bay in New Zealand.
21 comments:
"I think the long products would give a better longer term result in a market that was trending up as opposed to a market that has been rolling over but that's just an opinion."
How about 75% triple long S&P and 25% SDS for the long haul?
Not sure if you're joking.
what are you trying to create with that, if you're not joking?
I think that would leave you net long 1.75 times with no guarantee that it would ever trade like that.
I was trying to re-create something similar to your PST - TLT combo, unless I missed something on that one......
Maybe 25% SDS is way too much.
Over 12 months SPY is down 5% and the SSO is down 20%. For the calender year 2007 SPY was up 3.5% and the SSO was down 3.5% ~ there's something not quite right here. I can't quite put my finger on it because it's too opaque an instrument, but there's definitely something.
The last 12 months may have just been a worse case scenario for the SSO but I'd want to see a fuller history and positive returns against SPY to trust the product.
Or maybe the product doesn't work? As I understand it the leverage is gained through more than one instrument which causes the deviations in the return being exactly double the index. A deviation of less than 1% would be acceptable, but this much?
i have no interest in SSO but "doesn't work" may or may not be right. the objective is daily. I have not studied it to see how often it does what it is supposed to do on a daily basis but that is the only objective, daily.
Looking at the chart you can conclude it is not for you of course but there should be zero expectation of double long over a one year period. bonds might be different, that remains to be seen.
A point to try to clarify that I think most people looking at these double (triple) products seem to miss. You've got 3 sources of tracking error that will cause actual returns to deviate from theoretical:
1. Expense ratio: which for SSO is 0.95%
2. Interest cost: imputed cost of capital of the synthetic instruments they hold, let's guess it's in ballpark of 5%
3. Round trip tracking slippage: e.g. if underlying goes up 10% one day and down 9.09% next (so back to where started), 2x product will be up 20% and down 18.18% (down net 2%), so result is underlying flat will cause 2x leveraged to lose 2%.
To say the product "doesn't work" suggests that tracking error is significantly more than these three factors. While I admit I haven't done the day to day math on SSO, back of envelope suggests that with 1% expense ratio, 5% interest, the round trip slippage looks about right to me.
Now for a 3x product, the round trip slippage will get worst (exponentially), so it just suggests these are more short term trading vehicles than something you would want to buy and hold long term. This will be a big issue for high beta product like a 3x QQQQ.
I seem to remember someone introducing a gold etf that tracked 2x the monthly change. Personally I'd like to see a whole lot more of that since should eliminate most of the round trip problem, albiet at perhaps a slightly higher short term tracking error.
Michael
Exactly so: Very slight daily differences tend to lead to larger differences over time and that kind of slippage should be expected. A more interesting question might be whether groups like Direxion have any fundamental policies regarding long-term tracking -- that is do they make any attempt to "catch up" if the deviation from the underlying index is large enough -- but even if they did have such a policy (I'm not aware that they do) attempting to create synthetic long-short instruments out of these products seems misguided, far better in terms of long-term investing to keep expenses low and deploy products such as the Direxion funds as hedges against specific sectors or markets or as overall beta-modulators (damping or amplification) where your own trend modeling indicates that is appropriate. JMO
For a number of months, have been tracking DIG/DUG on a daily basis, because was thinking about employing DUG to hedge overweight oil/gas exposure. I'm assuming its the "slippage" that causes a fairly large deviance between the two on a fairly regular basis (if DIG is up 2%, DUG SHOULD be down by roughly 2%; often, there's a greater than 1% discrepancy).
Jan
the corelation of dig versus dug looks right to me but somehow (problems with the long version of these?) Dig lags IYE over six months and only beats IYE by a little bit over three months.
all within the fat tail of probability but fascinating nonetheless.
oh, is IYE the right benchmark?
These products recalculate daily - which has an adverse effect
Conventional Unleveraged Case : One day the stock price falls by 9% the next it rises by 10%, you're back to break-even over the two days. (0.91 * 1.1 = 1.0)
Leveraged Case : Twice scale the gains and losses of the conventional case and on the first day the stock falls 18% and the next it gains 20%, over the two days you're down 1.6% (0.82 * 1.2 = 0.984)
Clive
From http://www.direxionfunds.com/education/lif.html - "
If the value of the S&P 500 rises by 1%, then an investor should expect a gain of 2.5%, less fees and expenses, on their original $100,000 investment. However, if the value of the S&P 500 declines by 1%, an investor would have a 2.5% loss on the $100,000 investment."
Surely people don't want to take that much risk - do they?
Or is it diversification just for the sake of it?
We are in a bear market but 2.5X the exposure and [with bear rallies in mind] I guess it will be too much risk I guess?
i think that page is about their existing OEFs.
some people clearly want that sort of juice for speculation. depending on what someone has in mind htey can be an efficient way to temporarily equitize a portfolio--the risk being it doesn't do what you hope for.
"... the objective is daily. I have not studied it to see how often it does what it is supposed to do on a daily basis but that is the only objective, daily."
Can someone point to a link that explains why the sum of daily changes does not add up to the longer term change?
i think the earlier comments sum it it up quite nicely.
"3. Round trip tracking slippage: e.g. if underlying goes up 10% one day and down 9.09% next (so back to where started), 2x product will be up 20% and down 18.18% (down net 2%), so result is underlying flat will cause 2x leveraged to lose 2%."
THis would mean that they are doing something very different from just holding cash and futures contracts. If they did the latter then the futures contract should be flat when the index is apart from carry costs.
The other factor not mentioned is dividend payout. If SPY paid out a 2% dividend then SSO needs to pay out 4%. When the index is flat this will lead to more of a decline in SSO than SPY.
So I think, but could be wrong that the difference comes down to fees, interest, and a higher dividend payout.
Looking at the chart in stockcharts:
http://stockcharts.com/h-sc/ui?s=SSO&p=D&yr=2&mn=0&dy=0&id=p67245177324
It doesn't look down 20% in the last twelve months - this chart has been adjusted for distributions:
http://finance.yahoo.com/q/hp?s=SSO&a=05&b=21&c=2006&d=04&e=5&f=2008&g=w
wrong on the dividend front. it captures the daily price movement. divs have nothing to do with it. what it pays is interest from the t-bills held period.
i can't quite follow your other point.
How does the wash sale rule affect this product if the direxion ETF objective is on a daily basis? I could not buy and sell it on a daily basis without potential tax problems if I understand the wash sale rule .
I wasn't thinking straight on the dividends - if the index goes down 1% due to stocks going ex-dividend then the levered product's price will just go down twice as much, no different to the effect of any other price change in the underlying index. For some reason I was thinking this would make a difference, I was wrong.
My other point is that if the index goes up 10% and then down 9% and so has a flat performance over the two periods, I don't see that just by levering something two times you are going to get anything other than a flat performance as well. If I buy a futures contract and the index goes up 10% and then down 9% the next day why would the price of the futures contract be any different from flat over that period? (apart from the carry cost).
But the fact that they pay out interest on the T-Bills held but have to pay up front interest etc. built into the prices of the futures contracts they're buying would be an additional source of deviation in the price?
Well, maybe they are doing something different than buying futures contracts?
Sorry for my confusing comments. I was thinking out loud. I've done a statistical/econometric analysis of SSO vs. SPY:
http://moominhouse.blogspot.com/2008/05/how-well-do-leveraged-etfs-track-their.html
My conclusion it tracks two times SPY very well with the deduction of higher expenses and implicit borrowing costs at the risk free rate. The round-trip effect discussed here likely doesn't play a role.
I'll be surprised if these manage to attract much money. What's next? 4x leverage. 5x leverage.
I would think most people interested in getting this magnitude of leverage would simply use options, whether for short-term speculative trading or hedging purposes. With options, you can customize to the exact leverage level you desire.
I can see for someone not really interested in learning about options going the 2x leveraged ETF route to keep life simpler, but if someone really wants to go higher on the leverage, I think it is well worth the time to learn options because IMO they are superior to the leveraged ETFs for a multitude of reasons (bunch of old seeking alpha article with more detail on this)
The advantage of a leveraged ETF or mutual fund over just buying futures or options contracts is that if you hold it more than a year you can get the lower long term CGT rate, which is better than the 60/40 rate in the US for futures (or full marginal rate here in Aus).
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