Strategies for 2X & 3X Leveraged & Inverse ETFs
An integrative research study by Andreas Cseh
Introduction and Overview
Suppose you believe the market is going to go "crash", what would you do?
The normal answer is: sell what you have and get out.
However, what if you have nothing to sell?
Until a couple of years ago, the answer would have been "Stay on the sidelines" for simple investors.
The sophisticated and the professionals always had plenty of avenues:
- Shorting the stock
- Buying put options
- Selling naked calls, etc.
The gap was narrowed with the arrival of leveraged and inverse ETFs that allow even novice investors to short the market in a less risky way.
What are Inverse and Leveraged ETFs
Traditional ETFs track an index or basket in a one-for-one approach, they are basically passively
managed. In contrast, leveraged and inverse ETFs are intraday traded, "exchange-traded
derivative funds" and shouldn't be confused with more-vanilla ETFs. Leveraged ETFs require active
management: this involves borrowing funds to purchase additional shares (bullish LETFs),
or short-selling (bearish LETFs) and rebalancing the position on a daily basis.
At present, most levered ETFs are either 2X, 3X, -2X, or -3X, and therefore offer investors the chance to earn 2 or 3 times (and lose 2 or 3 times) the daily return of a simple long or short position in the index. These levered ETFs have leverage (borrowing) built into their structure, thus eliminating the need for investors to do their own borrowing (margin, futures, swaps, etc.) or short-selling, but the leveraging process is built to achieve an objective quite different from that of the simple, classical ETF. Read More»
Table of Contents of the Book
- Integrative research study goal
- Introduction and overview
- What are inverse and leveraged ETFs
- The main structure of a leveraged/inverse ETF
- Net asset value (nav) computation of a leveraged ETF
- Intraday Indicative Value (IIV) computation of a leveraged ETF
- Leveraged/long "bullish" ETF
- Inverse/short "bearish" ETFs
- Why inverse and leveraged ETFs lose money over long term?
- Creation of leverage
- Re-balancing
- Compounding effect
- The larger the daily volatility the greater the compounding effect
- Performance flip and volatility
- Mean and median returns
- Trading strategies for leveraged ETFs
- Strategy #1 – day trading
- Strategy #2 – the "market neutral" (beta=0)
- Strategy #3 - riding the volatility
- Strategy #4 – the "perfectly hedged"
- Conclusion
- Index of references
