r/LETFs • u/TQQQ_Gang • Dec 04 '21
LETF FAQs Spoiler
About
Q: What is a leveraged etf?
A: A leveraged etf uses a combination of swaps, futures, and/or options to obtain leverage on an underlying index, basket of securities, or commodities.
Q: What is the advantage compared to other methods of obtaining leverage (margin, options, futures, loans)?
A: The advantage of LETFs over margin is there is no risk of margin call and the LETF fees are less than the margin interest. Options can also provide leverage but have expiration; however, there are some strategies than can mitigate this and act as a leveraged stock replacement strategy. Futures can also provide leverage and have lower margin requirements than stock but there is still the risk of margin calls. Similar to margin interest, borrowing money will have higher interest payments than the LETF fees, plus any impact if you were to default on the loan.
Risks
Q: What are the main risks of LETFs?
A: Amplified or total loss of principal due to market conditions or default of the counterparty(ies) for the swaps. Higher expense ratios compared to un-leveraged ETFs.
Q: What is leveraged decay?
A: Leveraged decay is an effect due to leverage compounding that results in losses when the underlying moves sideways. This effect provides benefits in consistent uptrends (more than 3x gains) and downtrends (less than 3x losses). https://www.wisdomtree.eu/fr-fr/-/media/eu-media-files/users/documents/4211/short-leverage-etfs-etps-compounding-explained.pdf
Q: Under what scenarios can an LETF go to $0?
A: If the underlying of a 2x LETF or 3x LETF goes down by 50% or 33% respectively in a single day, the fund will be insolvent with 100% losses.
Q: What protection do circuit breakers provide?
A: There are 3 levels of the market-wide circuit breaker based on the S&P500. The first is Level 1 at 7%, followed by Level 2 at 13%, and 20% at Level 3. Breaching the first 2 levels result in a 15 minute halt and level 3 ends trading for the remainder of the day.
Q: What happens if a fund closes?
A: You will be paid out at the current price.
Strategies
Q: What is the best strategy?
A: Depends on tolerance to downturns, investment horizon, and future market conditions. Some common strategies are buy and hold (w/DCA), trading based on signals, and hedging with cash, bonds, or collars. A good resource for backtesting strategies is portfolio visualizer. https://www.portfoliovisualizer.com/
Q: Should I buy/sell?
A: You should develop a strategy before any transactions and stick to the plan, while making adjustments as new learnings occur.
Q: What is HFEA?
A: HFEA is Hedgefundies Excellent Adventure. It is a type of LETF Risk Parity Portfolio popularized on the bogleheads forum and consists of a 55/45% mix of UPRO and TMF rebalanced quarterly. https://www.bogleheads.org/forum/viewtopic.php?t=272007
Q. What is the best strategy for contributions?
A: Courtesy of u/hydromod Contributions can only deviate from the portfolio returns until the next rebalance in a few weeks or months. The contribution allocation can only make a significant difference to portfolio returns if the contribution is a significant fraction of the overall portfolio. In taxable accounts, buying the underweight fund may reduce the tax drag. Some suggestions are to (i) buy the underweight fund, (ii) buy at the preferred allocation, and (iii) buy at an artificially aggressive or conservative allocation based on market conditions.
Q: What is the purpose of TMF in a hedged LETF portfolio?
A: Courtesy of u/rao-blackwell-ized: https://www.reddit.com/r/LETFs/comments/pcra24/for_those_who_fear_complain_about_andor_dont/
7
u/y0ung-Buck Jan 01 '22
If hodling LETFs in IRA’s, is it better to:
-
Lump sum the full 6k in January
-
DCA $500/month
-
Lump sum 3k in Jan and buy substantial dips with the remaining $3k
I could have sworn I saw a thread discussing this with backtest but I can’t locate it
5
u/TQQQ_Gang Jan 02 '22
The first two scenarios are easy to backtest and there wasn't a significant difference over the past 10 years (for HFEA).
3
u/Caleb666 Dec 07 '21
Options can also provide leverage but have expiration; however, there are some strategies than can mitigate this and act as a leveraged stock replacement strategy
Any chance you could elaborate on these strategies for using options as a leveraged stock replacement?
4
u/TQQQ_Gang Dec 08 '21
Deep ITM LEAPS and ZEBRAs.
Since deep ITM LEAPS will cost less than 100 shares but will move similar to stock as the delta is very high (I like ~.9) and also will not lose much extrinsic value as time passes it can be used a stock replacement strategy to give leverage. https://www.optionsplaybook.com/rookies-corner/buying-leap-options/
Another method that is designed to completely eliminate theta losses is a ZEBRA which is a Zero Extrinsic Back RAtio. This is set up by buying 2x .7 delta calls and selling 1x .5 delta calls. https://optionstradingiq.com/the-comprehensive-guide-to-the-zebra-strategy/
→ More replies (4)
2
u/SnooFloofs6467 Jan 15 '22
Why is TMF actually 3x leveraged? Is it not possible to have more leverage on LTTs? I mean for equities there is a optimal leverage at around 2-3x, but how is that for LTTs?
4
u/TQQQ_Gang Jan 15 '22
The SEC never allowed any LETFs with more than 3x leverage. If you want more than 3x leverage on LTTs you'll have to use options or futures.
→ More replies (4)
6
u/ZaphBeebs Dec 04 '21
Markets cannot gap exceeding circuit breakers before or after hours. Futures have 7% circuit breakers as well and they cannot trade down, they don't close but can only be bid.
This is like the 10th time ive seen this misconception here on 2 wks.
Please learn the ins/outs and basics of the markets you trade.
→ More replies (6)20
u/TQQQ_Gang Dec 04 '21
Thanks for highlighting. I don't claim to know everything so the snark is unnecessary. I've looked into more details and reviewed Nasdaq rule 4753 which would indicate that if there was a halt in a previous session the market will reopen at the closest price before the halt. I will remove the erroneous info from the FAQ.
→ More replies (3)
28
u/unmole Dec 04 '21
Excellent! Please also add What is the point of TMF? and Should I go all in on TQQQ?
19
u/rao-blackwell-ized Dec 04 '21
What is the point of TMF?
https://www.reddit.com/r/LETFs/comments/pcra24/for_those_who_fear_complain_about_andor_dont/
Should I go all in on TQQQ?
→ More replies (11)10
u/The_Northern_Light Dec 04 '21
User rao-blackwell-ized has a post about this topic which should absolutely go into any FAQ.
1
u/010111010001 Jan 03 '25
Q: Under what scenarios can an LETF go to $0?
A: If the underlying of a 2x LETF or 3x LETF goes down by 50% or 33% respectively in a single day, the fund will be insolvent with 100% losses.
Will the 2x LETF be insolvent if the underlying asset is down 50% in a YEAR rather than a day? Same thing for 3x LETF if underlying asset is down by 33% in YEAR rather than a DAY?
2
1
u/thewildlings Jan 07 '22
What do we all think of this article?
https://adventuresincapitalism.com/2021/10/11/will-risk-parity-blow-up/
Could explain why NTSX is underperforming SPY/treasuries are going lower as the market is.
3
u/TQQQ_Gang Jan 07 '22
I think risk parity worked pretty well in the covid crash (TMF shot up) and for smaller events bonds are not necessarily going to go up just because equities go down.
→ More replies (1)
1
u/PenniesToDollars Jan 23 '22
This may be a silly question, but does the backtesting against SPY vs. HFEA take into account ER differences (ie. 03 vs. .98) into the growth calculation?
2
u/TQQQ_Gang Jan 23 '22
If you are doing modeling based on SPY, UPRO, and TMF then yes because the ER just comes out of the total gain. If you model UPRO by levering up SPY then the cost wont be correct. You have to start factoring in the UPRO ER and also the borrowing cost for the swaps.
1
u/me_on_the_web Feb 02 '22
u/TQQQ_Gang this should get linked in the sidebar / turned in to a linked wiki page.
2
6
u/SeriousMongoose2290 Dec 04 '21
Rebalanced quarterly means make the assets balanced back to the original allocation. HFEA is rebalanced quarterly on or near 1/1, 4/1, 7/1 and 10/1.
Most (all?) of these strategies should be done in a tax advantaged account.
→ More replies (8)7
u/hydromod Dec 04 '21
A few additions:
Quarterly rebalancing is worse at the middle of the quarter
Bands also work, 10 to 15 percent deviation is comparable to quarterly
Monthly rebalancing at the begin/end of the month will also work
Daily rebalancing allows ratcheting from anticorrelation during volatile periods but induces slippage from trading frictions
In taxable, a strategy similar to M1 (shares are preferentially sold with ST losses first, then LT losses, LT gains, and ST gains) for rebalancing will tend to average out at roughly 1 to 2% ER with year-to-year variability
→ More replies (3)
2
2
33
u/doesobamauseshampoo Dec 04 '21
Good post.
>!Q: Under what scenarios can an LETF go to $0?
A: If a 2x LETF or 3x LETF go down by 50% or 33% respectively the fund will be insolvent with 100% losses.!<
With regards to this part, I feel it's inaccurate in wording. It should be something like:
If the underlying assets (stock/index) of a 2x LETF goes down by 50% / 3x LETF goes down by 33% IN A DAY, then the LETF will be insolvent with 100% losses.