I sometimes bet on Do Not when I played Craps long ago, and am now inclined to make a small Bearish bet on the stock market just to “put my money where my mouth is.” I’m not optimistic about the Dollar either and would love to buy a Put with the Strike quoted in Yen or Euros but I don’t think there’s any easy way to do that.
Another option is to buy some ETF like SQQQ.
There are some similar ETFs, e.g. “Direxion Daily Financial Bear 3X Shares (FAZ),” but they all come with the admonition which is the subject of my question.
“Not suitable for most investors. These exchange traded products (ETPs) represent unique risks, including leverage, derivatives, and complex investment strategies. These securities are designed for daily use only, and are generally not intended to be held overnight.”
A graph of SQQQ vs QQQ shows that it fulfills its objective rather well. I examined the closing prices of QQQ and SQQQ on Jan 23, Apr 2, Apr 8, and Apr 21. Compared with January, QQQ was down 10.6%, 21.9% and 18.7% on the three April dates; while SQQQ was up 33.4%, 93.0%, and 51.2%. Roughly -3x as was their objective.
Am I correct that generally not intended to be held overnight is just another example of “professionals” warning amateurs about the WRONG risks, while ignoring some of the real but non-obvious risks? The graphs of SQQQ et al show no price glitches as might be expected if there was a big dump near market close. For that matter how is “generally not intended to be held overnight” even sensical? Somebody is holding these shares overnight.
More broadly this seems a bearish position. The real risk isn’t overnight holdings per se, but extended holding periods in volatile markets.
ISTM the issue is that these 3X leveraged ETFs reset their exposure daily. This daily resetting creates “volatility decay” or “path dependency,” which means that over multiple days, the ETF’s performance won’t simply be -3X the underlying index’s performance.
IANAFinancial advisor. Lots of other ways to say trading is risky and do not rely on anything I say about it.
Yes, that’s correct. No, it’s not a conspiracy. It rebalances daily. You can’t just buy and hold a triple leveraged product and expect it to match a given return 3X.
Those things exist for traders (pro or am, but mostly pro) to take intra-day positions on the market. After the market closes the fund “resets” to a different value to be ready to perform its 3X or whatever miracle during tomorrow’s intra-day trading.
The way those resets work, the amount of value you hold at the end of day 1 will be different from the value you will start day 2 with. And in a direction that gives back most of the superior intra-day performance you are seeking.
Just watching the prices from day to day doesn’t properly convey how they work inside.
Hence the admonition to not buy and hold over one night, much less over many consecutive nights.
I can’t speak to that fund exactly. But an acquaintance worked for a relatively small, private hedge fund. And he said that they didn’t leave a single cent of their billions of dollars of funds in the market overnight. They couldn’t predict what would happen and couldn’t react if something did. Therefore it was completely excluded from their investment strategy.
I’m not sure what you mean by this but the reason for this warning is because the long-run return on 2x or 3x leveraged funds is very different (and generally much worse) than simply 2x or 3x the underlying index. The concern when they were coming out would be that semi-educated financially literate people would think, “the stock market generally goes up more than other investments and in the long run, it always goes up, so a 3x leveraged fund will go up three times faster in the long run than a straight fund, so I’ll buy that one.” But it doesn’t work that way.
For example, assume an index ETF worth $1000/share and a 3x ETF coincidentally worth $1000 on the day you buy it. The next day, the index drops 10%. The Index ETF drops to $900. The 3x leveraged fund does exactly what it’s supposed to and drops to $700. The second day, the market recovers because the government undoes whatever stupid thing it did on the first day. The Index ETF goes up $105 (about 11.7%). The 3x levered fund does its job and goes up 35%. The index is up 0.5% in two days, which is a pretty solid return. How much did the 3x levered fund make? Did it make 1.5%? No, It lost $55. or 5.5%. Because it’s 35% return wasn’t on a base of $900 (like the index fund) but instead on a base of only $700. This is effect sometimes called compounding risk or volatility decay. ETFs also work in such a way that shares can be created in the morning redeemed by the end of the day with essentially no cost or harm occurring to the shareholders who do hold it longer. These markets are sufficiently liquid that the brokers creating and redeeming them can do so for very low cost themselves.
There are investors who can use funds like SQQQ to hedge risks that they do hold overnight as well as speculators who hold them for longer.
This is true because the values of the securities can change overnight, but it is equally true for the unleveraged Index Fund in my example or for any other investment. It is not the reason for volatility decay or for the warning.
I got burned badly back in 2008 holding leveraged ETFs like that. We did pretty well during the crash, betting it was going to get worse. The problem came when we bet against the recovery.
But it generally seemed that whether we were placing a bullish or bearish bet, the outcome over a week or two grossly lagged my naïve 2x or 3x expectation. And the longer the hold, the worse the results.
I never quite understood the why, but the what was unequivocal.
We eventually figured out the recovery was real and just went long on the S&P 500. But that was an enormously expensive lesson.
I thought about explaining how you could get similar effect to ‘buying a short-term FX put option’ through an online speculation platform, but decided that doing so would be both irrelevant and irresponsible.
I suppose I could summarize the lesson this way for others’ benefit. It seems obvious, but surely I’m not the only person to make it:
There are times when you can make money via speculation / “active trading”. But it requires continuous undivided attention. Not fire and forget, then check back in a couple months.
