I have been dabbling with leveraged (2x and 3x) ETFs for the last few months after first hearing about them, and they have been crushing it in my portfolio.

The most common strategy that I have seen written about is a combination (70/30, 60/40, 50/50, whatever) of UPRO/TMF. (UPRO = 3x S&P 500 and TMF = 3x 20+ year T-bills) Other combinations include subbing TQQQ (3x NASDAQ 100) for UPRO. You can run a backtest and see that these perform remarkably well, but the funds only go back to 2011 so the fact that they have only existed during a bull market.

3x ETF Portfolio examples (link) with 60/40 UPRO/TMF (Portfolio 1) and 60/40 TQQQ/TMF (Portfolio 2)



One might wonder: Why not just hold UPRO or TQQQ and forget the TMF component? Well, the volatility goes way up when you do that, even if the returns go up. Also, just like in a traditional portfolio, where you want to hold bonds with stocks, it provides a counter-balance should the market crash in the future.


The first hurdles for me to get past were:
1) leveraged ETFs are good short-term holdings, but are bad long term due to decay, and
2) the funds have only existed during a long-term bull market, so who knows what happens when we get to an extended bear market?

While these both seemed like valid concerns, upon reading more I found articles such as this one (link) which simulate the data back further back. (back to 1987 in the linked article) The results seem to indicate that holding the products for a long term in conjunction with each other can provide much better long term returns than anything by itself.

He simulated a 35/65 UPRO/TMF strategy back to 1987 which looks pretty good:



Also, after reading this article on leveraged ETF decay and understanding more what decay actually is and why it is not necessarily something to fear, I felt better about making the investments.

I am not sure if anyone else is even remotely as interested in this as I am, but if anyone is and wants to dig in further, I would suggest this 4-Part series titled "A Dead Simple 2-Asset Portfolio that Crushes the S&P500": Part 1, Part 2, Part 3, Part 4.

...and if you are REALLY interested, you can look at these threads on bogleheads.org: HEDGEFUNDIE's excellent adventure (warning: 68 pages) and the follow-up thread, HEDGEFUNDIE's excellent adventure Part II: The next journey (warning: currently 43 pages and growing)

If you read through them enough, you can see that some people use momentum strategies with these and other 3x ETFs (risk-parity, inverse volatility, etc.) to either increase returns, decrease volatility, or both. That is what I am most interested in now and coming up with strategies that maximize Sharpe and Sortino ratios is what I have been trying to do recently. Not sure if anyone is interested enough to have a discussion about more advanced strategies or not, so I will leave it there for the moment to see if there is any further interest.

Hope some others here are as interested in leveraged trading strategies as I am.

Thanks for starting a thread on this topic.

I've been dipping my toes leveraged waters a bit this year and I'm intrigued about developing a long term strategy.

I tend to disagree with you here:

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One might wonder: Why not just hold UPRO or TQQQ and forget the TMF component? Well, the volatility goes way up when you do that, even if the returns go up. Also, just like in a traditional portfolio, where you want to hold bonds with stocks, it provides a counter-balance should the market crash in the future.

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First, I'd argue that if you're looking to reduce volatility, you'd be better off doing a mix of say 35-50% TQQQ/SPXL/etc, and then put the rest in a mix of traditional bond funds... that is... don't put all your eggs in the treasury note basket.

But second, there are lots of people who are comfortable being 100% stock-based funds (and perhaps also individual stocks), because their retirement window is far away and they believe in the long-term growth of the market. You'd literally be doing the same thing with an "all-in" leveraged strategy... if you could control your emotions enough to not overreact.

Literally the only good reason I've seen from the experts as to why you shouldn't use leveraged ETFs as long-term investments is due to the volatility. And I don't mean to downplay that. It's no small thing from a psychological perspective, and I'd say that the magnified volatility means that if you're over 55 you probably ought to steer clear of them long term.

IMO, if you can overcome the emotional hurdle to even try 3x ETFs long-term, you might as well go all-in (if you're like 10+ years removed from retirement)

I've often thought that the best people who really ought to embrace a long-term leveraged strategy are the people who are fully on board with a dollar cost averaging, buy monthly and hold forever strategy. Those people have trained their brain to not care about market corrections and just trust in the long term growth. But of course the irony is that those folks tend to rely on long track records as the basis for their faith in the long term, so they're unlikely to entertain the idea of something new even though it more or less tracks the index they've based their faith in.

For my part (and I'm not the kind of person I just mentioned above) I am curious about a rotational system using the sector-based 3x ETFs and then looking at technicals and analyst opinions to rebalance weekly or monthly. I could see myself getting into something like that, but I've yet to develop the strategy. But I do have a strategy I've back-tested which is more of an all-in, all-out strategy, but I'll just go ahead and admit defeat and say it's doomed to fail so I don't trigger a market-timing debate.

Also, as I work up the courage to try this out - especially if I go with an all-in approach - I think I may ease into it.

For instance:

Start with PPLC, which is an S&P 500 with a very modest 1.35x leverage. Then as comfort level increases, upgrade to SSO at 2x; and then maybe graduate to a 3x.

Or maybe along the way up to 3x I learn that I dread every dip and make poor choices.

I've been following HEDGEFUNDIE's thread(s) for a few months. I took a flyer with a few taxable dollars in the 55/45 strategy.

We're also heavy PSLDX in our Roths.

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Literally the only good reason I've seen from the experts as to why you shouldn't use leveraged ETFs as long-term investments is due to the volatility. And I don't mean to downplay that. It's no small thing from a psychological perspective, and I'd say that the magnified volatility means that if you're over 55 you probably ought to steer clear of them long term.

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There is technically a minuscule threat of the leveraged funds wiping out, a la' XIV. But, UPRO resets it's leverage daily and you would need a string of the S&P's five worst historical days ever in consecutive sessions and without circuit breakers to do so.

Can someone direct me to a good article or book that covers this strategy? Are leveraged etfs just etfs that are somehow able to multiple the gains and/or losses that you would get from a typical index fund?

If that's the case, then I'd be very interested in that for long term investing.

mavsfan4ever said:

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Can someone direct me to a good article or book that covers this strategy? Are leveraged etfs just etfs that are somehow able to multiple the gains and/or losses that you would get from a typical index fund?

If that's the case, then I'd be very interested in that for long term investing.

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Yes, they use leverage (swap agreements, futures contracts, etc.) to attempt to replicate 300% the daily up (or down) movement of a certain fund. So, if the Dow goes up 1%, the UDOW fund goes up 3%, or if the Dow goes down 1%, then the UDOW goes down 3%.

In theory, one could take out their own leverage to do the same thing. If you read through those HEDGEFUNDIE threads linked above, you can see people arguing that taking out your own leverage would be a cheaper option, but I don't have an opinion on it.

I don't have any books or articles other than the above ones. Honestly, if you read through the HEDGEFUNDIE threads you will probably be almost an expert.

I would not set a defined percentage (the above examples were just examples). I am currently using an inverse volatility strategy to trade between a number of 3x ETFs.

Most leveraged ETFs have daily reset periods. Some rare ones have longer reset periods, like a month or a a lifetime or whatever. (examples) They will more accurately mirror the overall goal the investor is trying to get but the tradeoff is drift in asset allocation. So, if you have a daily reset period (most of them), then if a fund goes up 10% in a month, the 3x ETF might go up more or less than that because each daily increment might be different.

Also, you could go somewhere like Interactive Brokers and get a cheap leverage, and buy 3x ETFs and if you say, did double leverage, have essentially a 6x ETF. The downside is if the market ever were to fall 16.667% on a single day, you would be wiped out. (if everything were in a single ETF) There are a lot of Forex traders who trade at like 100X leverage. That just seems nuts to me, though.

I started way, way back in the olden days of 2010 with commodity leveraged funds, e.g. UGAZ, that were subject to complicated swaps and futures the resulted in backwardation and contango considerations.

And then I moved into VIX which is subject to volatility or mathematical decay.

I lose no sleep over UPRO. It's liquid and true to it's margin target.

deadbq03 said:

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I tend to disagree with you here:

Quote:

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One might wonder: Why not just hold UPRO or TQQQ and forget the TMF component? Well, the volatility goes way up when you do that, even if the returns go up. Also, just like in a traditional portfolio, where you want to hold bonds with stocks, it provides a counter-balance should the market crash in the future.

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First, I'd argue that if you're looking to reduce volatility, you'd be better off doing a mix of say 35-50% TQQQ/SPXL/etc, and then put the rest in a mix of traditional bond funds... that is... don't put all your eggs in the treasury note basket.

But second, there are lots of people who are comfortable being 100% stock-based funds (and perhaps also individual stocks), because their retirement window is far away and they believe in the long-term growth of the market. You'd literally be doing the same thing with an "all-in" leveraged strategy... if you could control your emotions enough to not overreact.

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Yeah, you can do what you want, but I think the thought behind doing 3x treasury bonds (TMF) in addition to 3x equity is that when the equity goes down, then the 3x treasury bonds will go up and vice versa as a kind of hedge. Traditional (non-leveraged) bonds would not have the same impact.

However, I have seen the arguments in the HEDGEFUNDIE thread that some feel that the cuts to the interest rates over the last few decades are pretty much done (can't go much lower) so there might be better funds to use than TMF moving forward. I believe EDV is the most common other suggestion to use.

If you do a timing strategy that maximizes for Sharpe or Sortino ratio, then you can get close to the returns of an all-in equity with much less volatility. This is basically what good hedge-fund managers and other good professional portfolio managers try to do, while amateur investors usually just try to maximize CAGR. (returns)

For instance, here is a test one I might trade in the future compared against TQQQ, where you can see the returns are pretty close but much less volatility on my timing model (visually you can see it moves up and down much less while the Sharpe and Sortino prove that it is a much less risky investment for the return given):

HustlerAggie said:

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Also, you could go somewhere like Interactive Brokers and get a cheap leverage, and buy 3x ETFs and if you say, did double leverage, have essentially a 6x ETF. The downside is if the market ever were to fall 16.667% on a single day, you would be wiped out. (if everything were in a single ETF) There are a lot of Forex traders who trade at like 100X leverage. That just seems nuts to me, though.

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Technically true with IB, but they have a scaling margin requirement for leveraged ETFs, e.g. 90% maintenance for 3x.

RangerRick9211 said:

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I started way, way back in the olden days of 2010 with commodity leveraged funds, e.g. UGAZ, that we're subject to complicated swaps and futures the resulted in backwardation and contango considerations.

And then I moved into VIX which is subject to volatility or mathematical decay.

I lose no sleep over UPRO. It's liquid and true to it's margin target.

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Aahh, VIX.

Do you remember the (now defunct) inverse, called XIV? (VIX backwards, of course)
It basically crashed and burned a couple years ago when VIX jumped quickly.

VIX (not the investment fund, the volatility index) is one way to track market volatility. I know there are some trading strategies (which I don't fully understand) based on using VIX to determine positions.

RangerRick9211 said:

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HustlerAggie said:

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Also, you could go somewhere like Interactive Brokers and get a cheap leverage, and buy 3x ETFs and if you say, did double leverage, have essentially a 6x ETF. The downside is if the market ever were to fall 16.667% on a single day, you would be wiped out. (if everything were in a single ETF) There are a lot of Forex traders who trade at like 100X leverage. That just seems nuts to me, though.

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Technically true with IB, but they have a scaling margin requirement for leveraged ETFs, e.g. 90% maintenance for 3x.

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Oh gotcha. I didn't realize how it worked. Presumably there is a brokerage that requires only the standard 50% maintenance for 3x ETFs? (or they don't even check?)
You can tell I have never actually done it.

HustlerAggie said:

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RangerRick9211 said:

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I started way, way back in the olden days of 2010 with commodity leveraged funds, e.g. UGAZ, that we're subject to complicated swaps and futures the resulted in backwardation and contango considerations.

And then I moved into VIX which is subject to volatility or mathematical decay.

I lose no sleep over UPRO. It's liquid and true to it's margin target.

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Aahh, VIX.

Do you remember the (now defunct) inverse, called XIV? (VIX backwards, of course)
It basically crashed and burned a couple years ago when VIX jumped quickly.

VIX (not the investment fund, the volatility index) is one way to track market volatility. I know there are some trading strategies (which I don't fully understand) based on using VIX to determine positions.

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You can't trade the VIX directly. Everyone used to trade VXX and XIV. The XIV meltdown was epic and a good lesson on daily resets. It melted after hours because of swaps to maintain leverage.

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If you do a timing strategy that maximizes for Sharpe or Sortino ratio, then you can get close to the returns of an all-in equity with much less volatility.

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Thanks for the reply and yeah, this is kinda the crux of what I'm thinking.

Even using highly simplistic signals for buy/sell would yield returns that still smoke the market. And that's even if your money is sitting idle when you're out. Something else like TMF or NUGT is likely to be doing well during the down cycle.

I really appreciate the discussion. Good points from you and Rick.

I'm too chicken to go big right now, but I'm planning to do so after the next correction. And in the meantime I'm researching and experimenting with small trades.

I work for 100B RIA and I'd warn all of you to be careful. Most of you seem educated on these but those just reading should watch yourself. IMO these should institutional investments only and shouldn't be available to retail investors.

ebdb_bnb said:

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I work for 100B RIA and I'd warn all of you to be careful. Most of you seem educated on these but those just reading should watch yourself. IMO these should institutional investments only and shouldn't be available to retail investors.

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Not saying you are wrong, but why do you believe this?

Most retail investors aren't educated enough on the "normal" investment options, much less leveraged products subject to contango & backwardation.

ebdb_bnb said:

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Most retail investors aren't educated enough on the "normal" investment options, much less leveraged products subject to contango & backwardation.

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Perhaps that is why Warren Buffet said, "There are three ways a smart person can go broke: liquor, ladies and leverage"

Also, if you google leveraged ETFs, about 90% of the articles are warning against using them as investment vehicles. (Usually because of decay.)

Having leveraged products as more than a small portion of one's overall portfolio might be a bit irresponsible.

A chart to visualize what happens during decay when leverage is used:

Leveraged ETFs belong only in the portfolios of mathematical engineers who possess a deep understanding of the double edge of the sword, and when to use them. They are not suitable for long-term buy and hold, which is why all of the big Wall Street firms have shunned them. They are an arbitration waiting to happen. Too much risk for average (and even most highly experienced) investors to understand. That's why you can only buy them in self-directed accounts where you have nobody to sue when it--inevitably--blows up your so called back-tested model. Just my $0.02

HustlerAggie said:

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A chart to visualize what happens during decay when leverage is used:

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What is the difference in decay rate or percentage as compared to average or regular fees paid to institutional investment firms for their funds that may largely follow a particular index? Are we talking 10% annual decay rate versus fees of .1% or are they closer in magnitude?

You obviously weren't trading a couple of summers ago. People have short memories, or little experience

deadbq03 said:

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HustlerAggie said:

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A chart to visualize what happens during decay when leverage is used:

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Thanks for the warning. I'll be sure to bailout early the next time the market makes a 61 day up-down run.

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Comments like these really tell more about you than anything.

Stagecoach said:

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Leveraged ETFs belong only in the portfolios of mathematical engineers who possess a deep understanding of the double edge of the sword, and when to use them. They are not suitable for long-term buy and hold, which is why all of the big Wall Street firms have shunned them. They are an arbitration waiting to happen. Too much risk for average (and even most highly experienced) investors to understand. That's why you can only buy them in self-directed accounts where you have nobody to sue when it--inevitably--blows up your so called back-tested model. Just my $0.02

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I know that Fidelity lets me buy them in all of my accounts I have with them, but Vanguard does not allow leveraged products to be purchased by any of their customers. (as of early 2019) I believe they banned them as a way to protect customers from themselves.

Red Rover said:

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HustlerAggie said:

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A chart to visualize what happens during decay when leverage is used:

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What is the difference in decay rate or percentage as compared to average or regular fees paid to institutional investment firms for their funds that may largely follow a particular index? Are we talking 10% annual decay rate versus fees of .1% or are they closer in magnitude?

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I am not sure of the ratio of decay to expense ratio (fees) if that is what you are asking. I know that the expense ratio (fees) for all of these leveraged (and inverse-leveraged) products can be higher than other more traditional ETFs.

For instance, the expense ratio for UPRO is 0.92% compared to S&P index funds which normally are less than 0.10% (VOO is 0.03%) However, you have to weigh that higher fee against what it would cost you to borrow the money to leverage up 3X.

claym711 said:

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You obviously weren't trading a couple of summers ago. People have short memories, or little experience

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I was merely making fun of their contrived chart. While it's useful to illustrate that these funds are bad in sideways markets, the truth is that even if you held these through a sideways or down market, the gains when it goes back up would more than make up for the decay/loss.

Most folks blindly dump money into Index Funds knowing that eventually the market will go up. My overall point is that leveraged is essentially the same thing... if you believe that long-term the market will go up, then in the long run these funds ought to go up as well.

Imagine a guy purchased SPXL in Jan 2018 before the tumult started; and then immediately after purchasing, he slips into a two year coma. When he woke up this month, he'd still have twice the gains right now compared to someone who purchased SPY at the same time (30% vs 15%). That said, I brought a coma into this scenario because that's probably the only way someone could hold this through the pain of last fall (50% loss). I don't deny the power of the psychological impact of these funds, but I would argue that that's the biggest downside.



Question for the group (especially Rick):

How offset are the risks that the funds could become insolvent if the major companies doing this (Direxion and Proshares) have a good bit of capital in inverse funds?

Proshares in particular seems to have a lot of assets in their inverse funds. Of their Top 10 leveraged and/or inverse funds they have $13.1B in Bull leveraged funds and $4.8B in inverse funds. And that's right now when most folks are bullish. Without question, that balance would start shifting if market sentiment grew bearish.

Would the performance of inverse funds provide a cushion against bull funds folding? Or are these funds set up so one fund could fail even if the company itself can meet the obligations from its gains elsewhere?

ebdb_bnb said:

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Most retail investors aren't educated enough on the "normal" investment options, much less leveraged products subject to contango & backwardation.

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Forgive my ignorance, but don't contango and backwardation only apply to futures? Or also to swaps?

Clearly I have a lot more to read and learn, but I'm curious why the derivatives involved in these ETFs are a cause for concern.

Anyone have a link to the HEDGEFUNDIE thread? I don't see it even searching.

This one from the op?

https://www.bogleheads.org/forum/viewtopic.php?f=10&t=272007

Also. Make sure you are looking at the share adjusted prices. BC of the decay, the leveraged funds often do splits or reverse splits, that arent always captured on charts. Some do.

There are also other side effects of long term leveraged etfs. Namely, they often dont track 2x positive and 2x negative correctly, ie, its often like 1.95x on up days but down 2x on down days.

Plus, when comparing to the underlying index you need to adjust for dividends. If you are taking the adjusted price, often what you see when you look at say, the S&P 500 over ten years, the price reported is often adjusted for dividend reinvestment. Leveraged etfs don't get that benefit. ie, SSO, 2X s&P, only has a 0.5% dividend while the S&P typically averages around 2%.

My point is, you cant just grab the long term s&p prices as reported and scale the returns by 2x since the returns as listed over long term are adjusted prices. The etfs track the daily return. So, the stock price may be flat, but the s&p etf will have gained the dividend, which will be reflected on the adjusted price, but not the price the leveraged fund trades against.

OlArmy01 said:

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Anyone have a link to the HEDGEFUNDIE thread? I don't see it even searching.

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Part 1:
https://www.bogleheads.org/forum/viewtopic.php?f=10&t=272007

Part 2:
https://www.bogleheads.org/forum/viewtopic.php?t=288192


It was in the original post, but I put a lot of stuff in there, so it is easy to miss.

Working nicely so far