Can we have a “Leveraged ETF’s: explained” thread?

The value of the leveraged ETF degrades over time. I don't completely understand how the degradation works, but it makes holding leveraged ETF's a bad play. Get in and out quickly. I personally prefer options if we are going for leveraged or riskier money.

Why to not buy leveraged ETFs:

1. They are very expensive.

2. There is nothing you can buy to get 3xS&P500, so they use many complex strategies to attempt to achieve this. Most folks would think volatility is your friend, but when using option strategies and being forced to rebalance to match an index in some cases on a daily basis, volatility up or down usually creates much more losses than gains.

3. Leverage cuts both ways, but protecting on the downside could be argued is more valuable than outperformance on the updside. Why? If you lose 10% value, it will take about 11% gain to get back to even. A 25% loss needs a 33% gain, a 50% loss needs a 100% gain, and an 80% loss needs a 500% gain.

TLDR - Don't buy leveraged ETFs for the long term

If you can emotionally stomach the volatility, leveraged ETFs can be effectively used. It's not for the lay person because it is extremely risky (but not because of the 'seesaw action' decay described by others because the market typically goes up more than it goes down; keep in mind that 'decay' math works the same way for 'growth'). I trade my leveraged ETF once a quarter, selling highs and buying lows. I've done extremely well and my losses during the downturn are just something you need to be able to handle. I know the risks and choose to play the game. It's been a winner for me.

If they're holding futures decay occurs when the contracts roll as well.

DDM anyone

These leverage ETFs try to put a multiple on daily returns. Depending on the daily sequence of returns, even if the underlier is up, the leveraged fund can be down. This unpredictability makes them unattractive for the vast majority of investors- not only do you have to gauge whether something is going up or down (which is hard enough), but also the daily gyrations that lead to that conclusion (which may as well be impossible). That’s why most people who use these things for a real purpose other than “it’s worked out for me” are hedgers looking for a daily position.

The S&P500 has probably had more "up" days, but I would have to research to confirm.

I think it would be interesting to do a daily analysis of the S&P 500, apply the leveraged returns, and compare the results to the underlying index to determine the long-term impact of leveraged funds. Sounds like a weekend project for me- will post results.

Over time, yes, there have been more up days. But let’s consider if the market trades sideways for a while within a 20% range. The index over that period would be flattish, while the leveraged ETF would suffer decay every time you cycle through the range. And what makes these so risky is that you may never recover that decay if the sideways trading persists long enough for the decay to become insurmountable.

Pulled S&P500 daily data from 1/3/1978 forward. Applied all the maths and considered if you invested $100 on any given day what the value would grow to for 1x, 2x, and 3x levered fund.

$100 invest in 1978 would now be worth $3,104.27 in 1x, $24,650.67 in 2x, and $46,159.79 in 3x. Over the past 22 years, 53.3% of the days have been up, 46.5% have been down, and 0.2% have been flat.

The 3x doesn't always win... here's a quick table since 2000 showing which fund would have been best to be in. The 3x does dominates in every date up to August of 1986. As expected,once you get into major downward volatilty the levered funds start to lose.

Buy Date | 1x Value | 2x Value | 3x Value | Winner
1-Jan-00 | $198.23 | $174.40 | $66.85 | 1x
1-Jan-01 | $220.59 | $226.91 | $106.87 | 2x
1-Jan-02 | $253.68 | $314.13 | $186.52 | 2x
1-Jan-03 | $331.03 | $572.08 | $506.96 | 2x
1-Jan-04 | $261.93 | $368.74 | $274.01 | 2x
1-Jan-05 | $240.32 | $314.24 | $219.57 | 2x
1-Jan-06 | $233.31 | $299.33 | $207.38 | 2x
1-Jan-07 | $205.35 | $234.20 | $145.70 | 2x
1-Jan-08 | $198.35 | $224.17 | $141.82 | 2x
1-Jan-09 | $322.44 | $702.97 | $1,025.04 | 3x
1-Jan-10 | $261.18 | $496.78 | $680.94 | 3x
1-Jan-11 | $231.58 | $403.49 | $523.53 | 3x
1-Jan-12 | $231.59 | $426.26 | $617.95 | 3x
1-Jan-13 | $204.21 | $336.82 | $444.67 | 3x
1-Jan-14 | $157.57 | $203.05 | $212.06 | 3x
1-Jan-15 | $141.46 | $165.78 | $159.53 | 2x
1-Jan-16 | $142.49 | $172.31 | $175.28 | 3x
1-Jan-17 | $130.09 | $146.11 | $140.45 | 2x
1-Jan-18 | $108.93 | $102.92 | $83.61 | 1x
1-Jan-19 | $116.18 | $120.54 | $110.77 | 2x

Here’s the flip side people aren’t talking about:

In a bull market, these leveraged funds will often return SUBSTANTIALLY more than 3x the index. Look at TQQQ from 2008 to 2019.

Of course, you better not buy a high or you can get into some trouble, because of what others have mentioned.