Author Topic: Leveraged ETF Degradation  (Read 5016 times)

Zach

  • Administrator
  • Hero Member
  • *****
  • Posts: 622
    • View Profile
    • Email
Leveraged ETF Degradation
« on: February 10, 2014, 08:19:05 AM »
I was wondering if anyone is familiar with the concept of degradation related to leveraged ETFs?

I know that it can cause lowered performance relative to the 1X ETFs (non-leveraged), but wouldn't the concept also be applicable (in terms of compounding) if the underlying ETF moves up in general?

For example, the SPY had a return of 18.41% in the last year, and UPRO (3X leveraged) had a return of 65.98%.. The leveraged version had performance that was actually greater than 3X - does this support my conclusion?

If this my guess is true, and it does work in both directions, then there would technically be more to gain than to loose, because overall, the market wins more than it looses in the long-run.

Lovinglifestyle

  • Hero Member
  • *****
  • Posts: 901
    • View Profile
    • Email
Re: Leveraged ETF Degradation
« Reply #1 on: February 10, 2014, 12:54:02 PM »
Man, if that puppy gets loose from the long run you're going to lose it for good!
That's all I know about this subject, for sure, lol.  Somebody qualified will chime in soon!

bobeubanks

  • Sr. Member
  • ****
  • Posts: 273
    • View Profile
Re: Leveraged ETF Degradation
« Reply #2 on: February 10, 2014, 01:20:33 PM »
Leveraged EFTs don't really perform in practice as they are suppose to in theory.

Fred

  • Hero Member
  • *****
  • Posts: 1421
    • View Profile
Re: Leveraged ETF Degradation
« Reply #3 on: February 11, 2014, 12:33:09 AM »
Most leveraged and inverse ETFs “reset” daily, meaning that they are designed to achieve their stated objectives on a daily basis.

Their performance over longer periods of time -- over weeks or months or years -- can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time.

The long-term returns of these ETFs are "path-dependent" -- http://www.math.nyu.edu/faculty/avellane/LETFSlides.pdf

Bohb Daishi

  • Sr. Member
  • ****
  • Posts: 481
  • I eat free lunches
    • View Profile
Re: Leveraged ETF Degradation
« Reply #4 on: February 11, 2014, 03:10:35 AM »
For example, the SPY had a return of 18.41% in the last year, and UPRO (3X leveraged) had a return of 65.98%.. The leveraged version had performance that was actually greater than 3X - does this support my conclusion?

The SPY has a dividend of ~2.1%, but the UPRO has a dividend of ~.17%. This would account for about 6% of the difference in the yield, assuming UPRO reinvests and SPY does not. Even then, the UPRO still has about a 4% higher return.

The degradation is highly dependent on what instruments are being used to provide the leverage. If they use debt, they are probably paying about 2-3% interest, or about 6-9% annual degradation with 3x leverage. But if they lever up by using futures contracts, the degradation would be a lot more difficult to calculate.
There are three ways to make a living in this business: be first, be smarter, or cheat.

OptionsTraderFL

  • Newbie
  • *
  • Posts: 26
    • View Profile
    • Email
Re: Leveraged ETF Degradation
« Reply #5 on: February 11, 2014, 08:26:55 AM »
If they are using futures I would think there would be a drag from rolling. Eventually they would have to reverse split the ETF like what was done with UNG and what is done with UVXY. I don't have any experience trading them long term.