Long term decay in leveraged ETF’s has created a stir with investors and regulatory officials. See this post on FINRA.  Daily volatility in the markets has eroded the ETF’s long term.  We found this blogger’s analysis worth the read on decay. “With the popularity of ETF’s came these funds which use 200% and 300% leverage. Yes in any steady trend they can grow like weeds, but in a correction they will give back much of their gains. This is simple, and basic math. First of all, these are extremely risky, and investor’s 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,” Marco Hickey reports from Option Maestro.

“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%,” Hickey reports.

“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 ETF’s 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 investor’s 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!,” Hickey reports.

“Basic math tells us this is not possible. 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 ETF’s 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,” Hickey reports.

See full article and analyzed spreadsheet: HERE

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