Following the footsteps of last week’s post, WTF is Wrong with Leveraged ETFs, I decided to take a look at whether leveraged ETFs can still perform as effective hedges. Also, I am continuing to explore if there are any anomalies to exploit when trading leveraged ETFs.
In my opinion, an effective hedge should not significantly limit possible profits but should significantly limit downside exposure.
For the first experiment, I chose to examine the relationship between [[FXP]] and [[FXI]], as FXP is the double inverse of FXI.
FXP is relatively new, which introduces some weakness into the research. The name has caused some considerable consternation for traders here at iBC. Thus, I decided that the lack of a large data set was not as important as using an example that might actually help traders here make money.
The experiment has one buy $5,000 FXP on the day of the IPO and $10,000 FXI on the same day. The purchases were made on November 8, 2007, and held through the close on June 6, 2008. The experiement has you buy only half the FXP because it is leveraged and should move 2x the daily movement of FXI. From my last piece on leveraged ETFs, we learned that since FXP tracks only the daily movement of the FXI, we would not expect it to mirror FXI over longer periods of time.
Have a look at the spreadsheet here: FXP as Hedge for FXI. (There are two charts in the spreadsheet)
Here is the bottom line:
- At the close on Friday, FXP shows a profit of $63.79
- FXI shows a loss of $2,525.34
Not much of a hedge, huh?
One interesting note: On March 19, 2008, FXI was showing its worst drawdown of $3,470. On the same date, FXP was showing a profit of $2,674.00. Still not great, but better than the final result. This just goes to show that these leveraged ETFs typically lose their ability to hedge the longer the relationship is maintained.
Future posts on leveraged ETFs will explore whether or not we should consider shorting the inverse ETFs. While the twist is sometimes hard to wrap the brain around, the results may surprise you.Â
love your ETF posts.
ultimately all leveraged short ETFs will go the way of the DCR over time. nevertheless, i’m also sure new ones will continue to replace them and begin the cycle anew.
good for trades over a couple of days, but i’d never stay in one for more than 3 days.
if you’ve got the cash and the margin acct, you could make guaranteed money shorting all of them over the course of a year.
the SRS kind of lucked out by opening at the absolute perfect point in time for that sector. i wouldn’t short that one until housing prices stop going down. once housing is back, that thing will fall off a cliff in a week.
I’ve looked at shorting the inverse etfs. The thing you have to be careful is is holding the short for long periods of time without adding to a short position. If you would short XYZ ultra etf and ZYX ultra inverse and XYZ went up 400%, ZYX could only go to 0 and give you a 100% gain. So it is aparent that you need to add to a short position as it declines, or wipe the slate clean and start new at even positions.
I looked at dig and dug and shorting both and the results were profitable (I think 10-20% in a year.) Then I looked at holding it for 2 years, and it was not. Month by month there were some periods where being short both would be a losing strategy.
Definately worth looking at though, I just haven’t had the time to look into deep details yet, so I appreciate the work you’re doing.
Thanks Aris and Hattery. I intend to explore the possibilities of shorting these over long time periods with a long hedge.
Interesting Wood. Run the numbers looking at a short of UCR and DCR starting in February.
Great stuff. I think it would be helpful to also look into the management fees for the ultras to determine what percentage of their underperformance is linked to that. I know the regular index ETF like QQQQ have extremely low management fees but they go up substatually for the ultras and that could certainly explain some of the long-term underperformance.
Good point bhh…I will determine what those are and add them to the equation for the next go round.
You will make money over the long run by shorting the ultra and ultra short etfs. You basically collect the management fees plus the tracking error (minus rebalancing costs). But that is only if you can short them. I’m pretty sure they are all hard to borrow. If you actually can borrow them, you will be better off shorting the ultra etf than you will be buying the corresponding ultra short one. You might be able to short the SSFs, but they don’t have many etfs on the SSF exchange (currently SSO is the only ultra etf on their etf page).
Shed, remember the book I mentioned recently (Tides in Affairs of Men). One of Smith’s theses was that unusual stock market activity is correlated to unusual weather patterns in the New York area. Well, it makes me wonder if he’s got a point.
http://wcbstv.com/national/June.Heat.Wave.2.743514.html
The 4 ultras I am currently holding all have shares available to short on IB
Boca, there as already been research completed that shows a relationship between cloudy/rainy days and the market, so that would not at all surprise me.
Good Stuff WS. Thanks for continuing the research
JakeGint
As el-midge has blocked access to his blog…now why might that be?….I shall respond to your last missive.
Clearly for a Common stock to fall to LESS than ZERO is an IMPOSSIBILITY.
el-midge postulated the $0.00 valuation.
That you did not contradict this valuation, rather implies that you agree, or condone this valuation.
I ASSUMED nothing.
You provided a MINIMUM target price of $5.00
Therefore, your valuation MUST reside somewhere between $0.00 and $5.00
See how the evidence starts to mount against your nonsense?
Evidence. Your own post;
“DUC — fair enough… I’ve been short since $32, so I see what you mean about “meat left on the bone.â€
At this point I’m looking at it fresh to see whether I’d want to hold, which means, for this kind of risk (ie, a massively shorted stock that could “pop†at any second), it has to head to at least $5 (like CORS).”
Thus, between the pair of you, you are in essence calling for bankruptcy…but have absolutely no idea what a bankruptcy might entail on a valuation basis.
What sort of incompetence is that?
jog on
duc
Duc,
You are conflating again. I am not the Fly, the Fly is not me. You cannot take my words as his, nor vice versa. The only logical framework you have to work with here is that we both are short FED and think it goes lower.
Let’s walk through this together:
At this point I’m looking at it fresh to see whether I’d want to hold, which means, for this kind of risk (ie, a massively shorted stock that could “pop†at any second), it has to head to at least $5 (like CORS).â€
In American English, all that says is that I’m looking for a target of less than $5.00. It does not say that I’m looking for “0” or even “BK.”
In fact, it’s likely I’ll cover in the $5 range, as I expect the final massive move to save it (by whomever) should occur right in that area. This is what’s called a risk adjusted investment play.
Now recognize, I’m not a professional investor, and I’m only offering my opinion. Do your own due diligence, etc. It seems you have, and if you are correct, we shouldn’t see much lower than where we are right now (the previous low was right here, as well).
We shall see.
_______
JG,
Of course you are not el-midge, never implied that you were.
You made a $5.00 MINIMUM call. Thus you believe for whatever reason, Fundamental, Technical, etc, that FED will see $5.00 or less.
Therefore, in your own words, your valuation/target MUST reach somewhere between $0.00 and $5.00
To try and claim otherwise, is simply the claim of a cretin.
You are not a professional investor. Hmmm.
Why then do you constantly refer to yourself as being in the business as…some form of investment banker?
Does that not rather imply that you consider your OPINION to be an INFORMED OPINION?
Rather than say an opinion of a ditch-digger?
jog on
duc
LOL.
If you think investment bankers are “professional investors” in the sense of asset management folk, I have a couple of questionable companies to sell you.
But no, I was strictly speaking of the difference between someone who sells their investment advisory services and, say, someone who sells an investment advisory service at “X” times cash flow to a strategic or financial acquiror.
I am not the former.
As for you claim that I believe the stock MUST fall somewhere between “$5 and $0” — true enough, but this does NOT mean I will wait til “$0 or BK” to cover my short, which was my only clarification.
Why are you posting on Woody’s blog, btw? There was a slight glich on Fly’s blog, but its okay now.
_
JG,
No I do not ascribe to investment banking the same skill set as asset management.
However, as you state, investment bankers who sell assets to acquirers of said assets, should, have some basic skills in the valuation of said assets.
As you claim to be the latter, then you in point of fact claim familiarity with valuation metrics, of assets/liabilities/cashflow
Therefore, your claim of offering an OPINION, rather implies that you believe your opinion to be INFORMED and PROFESSIONAL
Which is exactly the allegation that I made.
That you further claim a HINDSIGHT trade @ circa $32, but make the SHORT recommendation @ circa $15…rather brings your professional ethics into question.
All-in-all, it rather neatly summarises all that is wrong in American banking currently, n’est pas?
jog on
duc
Duc,
Pay better attention, next time. I announced I was shorting it in the mid-$30’s, too. Fly brought it to my attention, I checked it out, and it spelled “disaster” rather clearly.
It still does. My rudimentary “American” valuation techniques are only as good as the information I’m given, hence my “do your own DD” admonition. I am making some assumptions, after all — the largest being that the California RE portfolio FED has tar-babied itself into is going to continue to deteriorate, or at least remain very illiquid. Due to the already precarious position of it’s NPAs, I don’t think I’m making an extreme stretch here.
But we shall see, shan’t we?
)))))))))
For the record: I reiterate that it will trade to sub $5.
Amble.
JG,
What a load of nonsense.
You made no disclosure on your PG entry.
You flatter yourself unduely that I pay attention to your posting, most is a waste of bandwidth.
This however was a PG article that piqued my interest.
That you may have posted a “comment” somewhere, really does you no favours as far as ethical standards.
Here is a copy of the article
Why Short the FED?
by JakeGint on May 14th, 2008 at 1:45 pm
(11 votes, average: 4.27 out of 5)
Loading …
“Don’t fight the Fed†is the prevailing market axiom, and I won’t. But FirstFed Financial Corp (FED: 13.71 -9.98%), out of Santa Monica, CA is not the institution run by the bearded wizard with the magical printing press in it’s basements… very much to their chagrin. No, FED is a California bank that could be the poster child for the California real estate problem — torpedoed both by bad mortgage underwriting and the trick fuckery of option ARM loans that “trip†on signing and wait a stealthy one to three years to blow the legs and arms off their unsuspecting debtors. The extent of FED’s troubles is quickly revealed in their latest (first quarter 2008) 10-Q’s “Management’s Discussion and Analysis†(â€MD&Aâ€) section of that mandatory disclosure form.
Starting with the first paragraph detailing a decrease in shareholder’s equity of 10.3% in one quarter, there are multiple portfolio bomblets in almost every paragraph of the MD&A. Rather than belabor them all, I will point out a few of the more “limb severering†highlights:
1) Non-performing assets as a percentage of total assets increased to 6.21% at March 31, 2008 compared to 2.79% at December 31, 2007 and 0.46% at March 31, 2007. That’s right, that’s a 123% increase in one quarter, and a 1,250% increase since last year. That’s a percentage of TOTAL ASSETS, people, which stood at $7.1 bn at quarter end. Consider that current shareholder’s equity is down to $587 million… and now figure in $441 million of non-performing loans… Voila!
In the “worst case scenario†(total immolation of NPA’s), we’re down to $146 million of book equity — even making the egregious assumption that the NPA percentage does not increase any more than it has. Can we even attempt that assumption with California residential real estate down almost 30%, year-on-year as of the end of March? And how does our current market value at $15.25 a share, compare with that book value estimate you ask? At a $208 mm market cap, we may be a tad “optimistic†here. For those that say FED is “beaten down,†I say “Look at all those remaining extremities!â€
2) Single family non-accrual loans (loans greater than 90 days delinquent or in foreclosure) increased to $393.6 million as of March 31, 2008 from $179.7 million as of December 31, 2007 and $33.9 million as of March 31, 2007. Additionally, single family loans delinquent less than 90 days increased to $273.3 million as of March 31, 2008 from $236.7 million as of December 31, 2007 and $12.0 million as of March 31, 2007. What does this tell us? Namely that the stankiest of “seeya†non-performing loans have increased 119% since just last quarter, and 1,061% since last year. In addition, the pipeline at the “less than 90 days†non-accrual side, continues to expand as well, albeit at a slower pace (15.6%) than those flipping into the “over 90 day†column. Part of this “less fast†growth is due to the law of large numbers, so what’s important to “take away†here is that the NPA problem is not over. And why not?… well let me leave you with my last shrapnel grenade:
3) At March 31, 2008, 99.8% of our loan portfolio was invested in hybrid and adjustable rate products. WTF?? Who was the strategic genius behind this asset allocation? And just look at these underwriting “requirements†underlying their existing portfolio…. (hint: only the very first group can be considered close to “safe.†It’s 27% of their total portfolio!):
Documentation Type:………………. March 31, 2008…..December 31, 2007……March 31, 2007
($ In thousands)
Verified Income/Verified Asset……………$1,214,599………….$1,135,358…………$1,203,629
Stated Income/Verified Asset……………..1,383,098……………1,468,686…………..1,930,482
Stated Income/Stated Asset………………1,420,761……………1,506,627…………..2,021,496
No Income/No Asset …………………………492,899………………542,205……………..691,499
____________________________________________________________________________________
Total………………………………………..$4,511,357………….$4,652,876…………$5,847,106
Remember, I’m just looking at the balance sheet, here. I’m not even drawing to your attention the fact that these numbnutzes are doing very little in new lending, thanks to the fact that their chosen “market niche†is making the Long March into the Ninth Circle of Hell (the Honorable Angelo Mazilo, presiding). No, FED is an arm-and-legless caterpillar thanks to the fact that their non-performing assets are quickly overtaking reserve capital, and in a regulated business, that means they will be getting a “visit†very soon. If it’s not from a vulture capitalist “getting his taste†at “Bear Stearns levels,†then it will be from the Office of the Comptroller saying “Fuck you, you’re dead.†Short it at will, but $16 looks like a nice entry here.
************
This entry was posted on Wednesday, May 14th, 2008 at 1:45 pm and is filed under Stock Picks. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
I can detect no disclosure statement in the article.
jog on
duc
What can I say, you need to pay more attention.
Don’t get exiled so often and you’ll hear shit when it goes down.
Everyone but Fly’s blind and deaf Romanian goats knew we’ve been short this since the early thirties. You must have been off getting pissed or something.
So solly.
It’s irrelevant, in any case, as I reiterated my short at $15+ and in fact said that $16 would be a good entry. I was short then, and I’m more short now.
So fuck off.
haileris;
Cannot answer you on el-midges sorry excuse, blocked. So, as it happens I am a big fan of Taleb, that however is a moot point.
You assert that FED’s books are lying.
Really?
Where exactly are the lies being told?
jog on
duc
JG,
Ooooh, such an internet tough guy.
Must be all that wrestling background you claim.
jog on
duc
????
This isn’t tough guy, loser, it’s “basic New York.”
Try not to be such a femme. Sheesh.
JG,
You see…you’ve become all emotional.
With the emotional outburst comes the aggressive language and pose.
If I wasn’t thousands of miles away…I’d be really scared, after all…a New Yorker using profanity…terrifying.
jog on [very respectfully]
duc
Duc,
Get a grip on yourself. This is the way I talk to all the annoying douchebags on this site. You’re only “mostly annoying.” I don’t know what’s eating you, but perhaps you need some time off.
If you have anything relevant or interesting to say, perhaps I’ll go back to treating you like someone to whose opinion I care to attend. In the meantime, be sure to continue fucking off.
Another Jake win.
in point of fact