Comments by "seneca983" (@seneca983) on "Leveraged ETFs - Not The Return Cheat Code You'd Expect" video.

  1. Have you seen Wallstreet Millennial's video on this subject? He considered investing in the Direxion Daily S&P 500 Bull 3X ETF. With historical data, it would even in the long run greatly outperform the SPY ETF despite volatility drag. It might be worse if only made a one-off investment and the timing was bad but with dollar-cost averaging you'd still be better of than with SPY. This got me thinking, would it be possible to make a leveraged ETF with long-term investing in mind? It could maybe contain stocks from multiple countries for better diversification and maybe weigh less volatile stocks more. Also, it might not need to fully rebalance daily to mitigate volatility drag.
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  2. In a certain sense, volatility drag is always negative. Let me explain. Assume that the value of the index moved continuously and that a leveraged ETF tied to that index were rebalanced at every infinitesimal moment meaning its price's logarithmic derivative were always 3 times that of the logarithmic derivative of the index's value. Such an ideal leveraged ETF would experience zero volatility drag. Its value growth would be raised to the 3rd power so if the index grew by a factor of 2 over some time period the value of the ETF would grow by a factor of 8. If the index grew by a factor of 10 over some period of time the ETF would grow by a factor of 1000. A real leveraged ETF that's balanced daily and not at each infinitesimal moment will always lag behind this kind of idealized ETF. The more the index moves between rebalancings the more the real leveraged ETF lags behind this ideal.
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  3.  @4CiiD3  "The least time you rebalance leverage, the least amount of volatility drag you will get." No, it's not how frequently you rebalance. Rather it's how much the price moves between rebalancings. The hypothetical ideal ETF rebalances at each infinitesimal moment so the price only moves an infinitesimal amount between rebalancings (assuming continuity which isn't realistic either) so there's no drag. "And when you say volatility drag is always negative... negative in what sense ?" I already explained that. The hypothetical ideal is that returns get raised to the 3rd power (with 3x leverage) if there's no volatility drag at all. Due to volatility drag, a real leveraged ETF will always lag behind this ideal. The less the index moves between rebalancings (i.e. the less there's day-to-day volatility if rebalancings happen daily) the closer the leveraged ETF will get to this ideal but it will never reach it. "Average return is still 3x index - costs no matter how you rebalance." It's (generally) not 3x over multiple days (assuming daily rebalancing).
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  4.  @DarthTrader707  It seems you didn't understand what I wrote. None of what you wrote about TQQQ contradicts what I wrote. "Since inception, TQQQ is up 147 times vs 8 times for the QQQ." Like I wrote, a hypothetical 3x leveraged ETF that is continuously rebalanced and suffers no volatility drag would raise the returns to a power of 3 (ignoring fees etc.). So in this case such ideal version would provide 8^3=512 returns. TQQQ will inevitably lag behind this ideal performance (in this case providing "only" 147 times returns) due to volatility drag. It can still greatly outperform the index if the volatility drag isn't too great.
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  5.  @bultvidxxxix9973  "No, there will always be volatility drag. The reason is that you apply a linear factor to something that doesn't scale linearly." I'm not sure what you're referring to here. I only said a hypothetical ideal ETF that rebalances at every infinitesimal moment wouldn't experience volatility drag. In real life, that's not possible for various reasons (e.g. stock prices don't really move continuously.)
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  6. "Every is instrument that is volatile has volatility decay, non-leveraged ETFs have it too" No, the volatility drag is due to the daily rebalancing. Non-leveraged ETFs don't have to be rebalanced.
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  7.  @mariorossi7149  "If a index goes down by 10% and then goes up by 10%, it losts 1% of its value." That's just an artifact of the definition of percentage change, not a "real" phenomenon. If you multiply an index by a factor of 1.1 and then divide it by the same factor it'll end up where it was but a leveraged ETF following the index will lag behind.
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  8. What? Like an ETF where half of the content is cash and only half is stocks? What would be the point of that?
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  9. You can avoid a lot of the volatility drag if you e.g. never rebalance downwards. For this, your leverage needs to be small enough that you don't need to rebalance downwards in a falling market to avoid a margin call. This will limit how much the leverage can boost your returns.
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  10.  @martinbacik2724  Thanks.
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  11.  @NapalmXD  Sure. Assume you invest $1000 of your own capital in an index and also take a $2000 loan for 3x leverage so your total leveraged position is $3000. If the index grows 2% in one day your total position becomes $3060. But now your leverage isn't 3x anymore so to rebalance you have to take $120 of additional debt. After that, your total position will be $3180 with $1060 of your own capital. Then the next day the index goes down by 1.9%. 1.9% of $3180 is $60.42 so your total position will be $3119.58. Now the leverage is slightly above 3x so to rebalance you have to sell $120.84 worth of stock to pay off that amount of debt. Your total position will then be $2998.74 with $999.58 of that being your own equity. So on the first day, you gained $60, and the second day you lost $60.42 for a net loss of $0.42. If you had just invested $1000 of your own money without leverage your gain on the first day would have been 20$ and your loss on the second day $19.38 for a net gain of $0.62. Does this clarify?
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  12.  @NapalmXD  Because the fund is designed to replicate the daily return of the index 3x (or some other ratio). For that, the leverage ratio has to be 3x at the beginning of the trading day. If the index has moved and the fund doesn't rebalance then the leverage ratio will be different and the fund will provide a different return than designed.
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  13.  @NapalmXD  If you mean an ETF that uses debt but never rebalances then one would over time become fairly pointless. Let's say you start a 2x leveraged ETF following the NASDAQ composite index in 1982 when the index is at 200. At the start 50% of the fund is debt and the other 50% is its own capital but the fund never rebalances. In 2020 the index reaches 10,000. Now (ignoring fees) the fund is composed only of 1% and 99% of its own capital. The leverage ratio has fallen to about 1.01 making the fund barely any different from a normal unleveraged ETF and thus fairly pointless. Or maybe you meant that the fund could rebalance and take on more debt if the index grows but are not specifying when or on what condition the fund would rebalance and how much. Then the question becomes too vague to answer. You're basically asking about ETFs using debt but don't specify anything about how they use debt. There just isn't enough info to answer your question unless you provide a bit more specifics.
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  14.  @HaloDude557  Though you should remember that some other leveraged ETF have probably underperformed the related index.
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  15.  @mariorossi7149  A non-leveraged ETF doesn't have volatility drag. If the index it follows drops, say, from 100 to 90 and then rises back to 100 a normal ETF following that index will also bounce back to where it was (ignoring fees) but a leveraged ETF will not.
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  16.  @nikolagenov8881  If you hypothetically start with 3x leverage but don't take any more debt if your investment appreciates in value, you get 3x gains compared to your original equity. This means your leverage ratio goes down when your investment appreciates in value. If you instead take more debt keeping the 3x leverage ratio you get bigger gains. If you can adjust your debt in infinitesimal increments always keeping the 3x ratio you would, in theory, get gains to the power of 3. In the real world, you can't update your debt level infinitely often so volatility drag will cause your gains to be lower. Additionally, you're also going to incur interest on debt, transaction costs, and other costs which are also a drag.
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  17.  @NapalmXD  Even if the ETF were to actually use loans the result would still be the same if it also rebalances daily.
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  18.  @NapalmXD  Well, what kind of rebalancing schedule are you thinking about?
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