Wednesday, December 2

SPXU Enters Positive Drift Regime

The ProShares UltraPro Short S&P 500 ETF (SPXU) is one of the most popular instruments to short the broad market for trading or hedging purposes. However, its daily -3X leverage factor is a source of drift. It must be closely monitored to detect changes in the drift regime. This article explains what “drift” means, quantifies it in more than 20 leveraged ETFs, shows historical data on SPXU, and finally, concludes about the current market conditions. The analysis is also valid for Direxion Daily S&P 500 Bear 3X Shares (SPXS), which tracks the same index with the same factor and has an almost identical behavior.

Why do leveraged ETFs drift?

Leveraged ETFs often underperform their underlying index leveraged by the same factor. The decay has essentially four reasons: beta-slippage, roll yield, tracking errors, and management costs. Beta-slippage is the main reason in equity leveraged ETFs. However, when an asset is in a steady trend, leveraged ETFs can bring an excess return instead of a decay. You can follow this link to learn about beta-slippage.

Monthly and yearly drift watchlist

A few definitions are necessary before going to the point. “Return” is the return of a leveraged ETF in a given time interval, including dividends. “IndexReturn” is the return of a non-leveraged ETF on the same underlying asset in the same time interval, including dividends. “Lv” is the leveraging factor. “Abs” is the absolute value operator. “Drift” is the drift of a leveraged ETF normalized to the underlying index exposure in a time interval. It is calculated as follow:

Drift = (Return – (IndexReturn x Lv))/ Abs(Lv)

“Decay” means negative drift. “Month” stands for 21 trading days, “year” for 252 trading days. A drift is a difference between 2 returns, so it may go below -100%.

IndexLvTicker1-month Return1-month Drift1-year Return1-year Drift
S&P 5001SPY7.24%0.00%23.70%0.00%
3UPRO23.03%0.44%27.60%-14.50%
-3SPXU-19.46%0.75%-72.01%-0.30%
ICE US20+ Tbond1TLT-3.47%0.00%13.26%0.00%
3TMF-9.52%0.30%20.70%-6.36%
-3TMV10.70%0.10%-47.48%-2.57%
NASDAQ 1001QQQ11.34%0.00%62.86%0.00%
3TQQQ37.08%1.02%189.12%0.18%
-3SQQQ-28.92%1.70%-88.17%33.47%
DJ 301DIA7.76%0.00%12.20%0.00%
3UDOW24.76%0.49%-9.92%-15.51%
-3SDOW-20.78%0.83%-66.39%-9.93%
Russell 20001IWM4.97%0.00%8.75%0.00%
3TNA14.72%-0.06%-29.55%-18.60%
-3TZA-14.22%0.23%-70.59%-14.78%
MSCI US REIT1VNQ1.87%0.00%-8.92%0.00%
3DRN4.52%-0.36%-60.40%-11.21%
-3DRV-6.50%-0.30%-49.70%-25.49%
MSCI Emerging1EEM3.92%0.00%16.52%0.00%
3EDC11.21%-0.18%5.26%-14.77%
-3EDZ-12.14%-0.13%-66.43%-5.62%
Gold spot1GLD-0.32%0.00%26.96%0.00%
2UGL-2.31%-0.84%44.79%-4.57%
-2GLL-0.26%-0.45%-41.92%6.00%
Silver spot1SLV14.95%0.00%46.12%0.00%
2AGQ25.73%-2.09%66.90%-12.67%
-2ZSL-33.18%-1.64%-70.69%10.78%
S&P Biotech Select1XBI-3.83%0.00%39.31%0.00%
3LABU-12.70%-0.40%53.34%-21.53%
-3LABD8.24%-1.08%-85.67%10.75%
PHLX Semicond.1SOXX5.97%0.00%57.73%0.00%
3SOXL17.56%-0.12%92.93%-26.75%
-3SOXS-17.88%0.01%-92.82%26.79%

The best and worst drifts

  • The leveraged silver ETF (AGQ) has the worst monthly decay with a drift of -2.09%.
  • The leveraged semiconductors ETF (SOXL) is showing the worst decay in 1 year with a normalized drift of almost -27%. The leveraged inverse real estate ETF (DRV) and the leveraged biotechnology ETF (LABU) are not far behind.
  • The inverse leveraged Nasdaq 100 ETF (SQQQ) has the highest positive monthly and yearly drifts: +1.7% in a month, +33.47% in a year (in a large loss due to a steady uptrend in the underlying index).

A positive drift comes with a steady trend in the underlying asset (whatever the trend direction and the ETF direction). A negative drift comes with daily return volatility (“whipsaw”). Whipsaw happens more often in downtrends: downtrends make investors nervous, so steady downtrends are very rare.

SPXU drift is positive again

SPXU has a positive drift on long periods, as reported in this article. However, I have issued a warning on 3/10 (3/5 for subscribers) against SPXU and generally against leveraged equity ETFs. Trading or hedging with SPXU has worked very well in the first week of the market meltdown (2/21 to 2/28): SPXU has gained 39.98%, significantly more than SPY return on the same period of time (-11.16%) multiplied by the leveraging ratio (-3). It is a 6% excess return due to beta-slippage. Then, whipsaw action has resulted in a heavy drag in a few weeks in March: SPY has lost 17.5% and SPXU has gained only 15.54% in the same time. It means shorting SPY was a better trade than buying SPXU, despite the leverage factor. Then, the drift was positive in April (+1.8%), negative again in May (-0.3%), and much worse in June (-4.1%). It has been positive again in July (0.2%) and August (0.75%).

The chart below shows that the 12-month drift came back close to positive territory after hitting the worst value in 10 years.

12-month normalized drift of SPXU since it is calculable (1 year after inception). The average is positive.

SPXU is a cheap instrument for hedging a portfolio in a bull market compared with other derivatives. However, it may suffer a significant decay when the S&P 500 daily returns are volatile. Its drift became strongly negative in March, and it was better to avoid it during a few months. In the current context of a stretched rally and low volatility, it may be once again a good way to partially hedge a stock portfolio against a possible correction. However, SPXU must not be kept if whipsaw comes back: instruments with less or no leverage should be preferred in this case. The real drift of a hedging position depends on rebalancing dates. Rebalancing close to technical support and resistance zones may partly or totally offset the drift even in volatile times, but this is path-dependent and unpredictable.

<

p class=”p p3″>Anyway, leveraged ETFs are only for investors and traders with a good understanding of the products behind the advertised leveraging factor. Like for any ETF, read the prospectus, and if you have a doubt, stay away.

Since 2015, Quantitative Risk & Value (QRV) provides a systemic risk indicator and strategies based on it. SPXU may be used in hedging tactics scaled according to the market’s risk level and the investor’s risk tolerance. In a world of probabilities, it is a more realistic approach than just risk on/risk off. Get started with a two-week free trial and see how QRV can improve your investing decisions.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Credit: SeekingAlpha

Leave a Reply

Your email address will not be published. Required fields are marked *