Leveraged ETFs - holding periods

Self bump. Any CFAs in the house?

Here is a link with some individuals take on leveraged ETF's.

LINK

I think you already posted the main concept - volatility will eat into your return over the long run.

LINK

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Lets say that an index goes up 10% one day and down 10% the next. Over the two day period, the index is would have lost 1%. Although the average return is zero, the compound return is less than that due to volatility. A 3x leveraged product would have lost 9%.

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Now I've heard colleagues reasonings; that there is a large decay factor, daily adjustments to NAV... But does anyone know the real reason you don't hold a leveraged ETF for long time horizons?

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I mean that's the reason.

ETFs are much more complicated vehicles than people realize. You have to post collateral back and forth on some positions and there is usually one specialist trying to keep exposures constant for pretty heavy inflows and outflows, and this is just extrapolated when the ETF is leveraged. That's just flat out fricking hard to do. Think of it this way, the more you have to buy and sell securities for an ETF the more decay you'll possibly have. The pinnacle example for this is to just look at the VIX and look at the VXX compared to it. That is the definition of decay in the marketplace because you have to constantly roll options and you're being compared to a model index that doesn't have to actually buy and sell options.

A perfect example of how ETFs can be not what they seem, a certain treasury ETF in August of 2011 was 30% collateralized by Italian bonds.

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Why couldn't I do this with the "Bear" fund over the next 5-10 years? I feel like I'm missing something. I have attached screenshots of both charts below

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You could, but the returns you'll get will not equal the opposite of treasury returns during that time span just as BULL's returns were less than the returns of an actual long bond during that time. I would never own an ETF for over a couple weeks. The decay is just too much.

Although the mathematical relationships the blog said are true, they don't address the underlying fundamental reasons why decay will always happen with ETFs and especially leveraged ETFs. I posted the below in another thread which echoes what I said above.

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In July 2011, there was a leveraged US Treasury ETF collateralized with 30% Italian BTPs. Are you kidding me? Sure, you see your holdings for an ETF but if you're in a leveraged ETF and you have to post collateral, or the value of your collateral gets haircut you're going to have to start scrambling, selling securities into a likely sell-off to meet margin. Then you turn around and try to match your exposures with the index you're trying to track? It's almost impossible to do. Even the best specialists that use uncorrelated collateral against their ETF assets are still going to have trouble tracking. That's not even taking into account re-weighting after new inflows/outflows, you can see how this can go downhill fast.

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In addition to the above, volatility ETFs have to constantly roll options to keep exposures, incurring transaction costs. That is something that the VIX does not do because it is a model portfolio. Hence continued erosion of returns.