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Help me on this ETF math! -( ETF decay video )

post #1 of 14
3/12/09 at 1:54am
Thread Starter 
I need some help wrapping my mind around how DXO, which is an ETN that is leveraged 2x price of crude, has fallen from a high of 29.65 to 2.22. This is a 92% decrease, yet crude has fallen ~72% from its highs, back when DXO was 29.65.

Further, lets assume oil goes from $42 back to $150. This is a

((150-42)/(42))X100= 257% increase.

However, a 257% increase from DXO's current $2.22 price would bring it to $13.36 (with 2x leverage). Here's my math for that.

((x-2.22)/(2.22)) = 2.57*2

x - 2.22 = 11.14

x = $13.36

As you can see, even with oil at its high of 150, the DXO would not be at its high of $29.36.

Can someone illuminate how this is possible, whether or not my math is wrong, and if my math is not wrong, what this means about ETFs?

Due to ETFs tracking percentage changes and not price movements, does this mean that volatility inevitably results in price depreciation for ETFs? Thus, wouldn't it be prudent to short ETFs as soon as they come on the market?
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post #2 of 14
3/12/09 at 2:08am
Your math is fine, its called volatility decay.

Same thing with IYR and SRS the inverse x2 etf.



Above we see IYR making a low in Nov and making a lower low in March.

Now look at what SRS did:



SRS did not even come close to making a new high... Volatility decay.

One could argue that these kinds of ETFs are all headed lower in the extreme long term unless they do something to change they way they are calculated.
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post #3 of 14
3/12/09 at 2:15am
Thread Starter 
Can you short these ETFs? I did in fact notice the same thing with SRS, I was once long it, but can you short a short ETF or short a long ETF? I've never tried it.
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post #4 of 14
3/12/09 at 3:33am
Stockjocke dont forgot about gaps when your talking about commodity tracking etfs. Specifically crude oil and natgas, when the ETF switches to the new month for reference it quite often gaps up or down. The ETF does not change in value to reflect that gap up or down accordingly. They are merely used to capture daily and intraday percentage moves of the desired commodity. Crude oil ETFs have suffered from 'contango decay' heavily the last few months. In addition I am not aware of how European and Asian hours trading is reflected in the reference points for DXO USO HOU.to etc. There is far more to these badboys then what meets the eye thats for sure. I dont trade them much anymore the contango decay was absolutely killing the returns. Index trackers are so much simpler
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post #5 of 14
3/12/09 at 3:47am
Quote:
Originally Posted by dfall View Post
Can you short these ETFs? I did in fact notice the same thing with SRS, I was once long it, but can you short a short ETF or short a long ETF? I've never tried it.
Yes you can; also you can buy Puts or write naked Calls on them.
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post #6 of 14
3/12/09 at 3:51am
Quote:
Originally Posted by dfall View Post
Can you short these ETFs? I did in fact notice the same thing with SRS, I was once long it, but can you short a short ETF or short a long ETF? I've never tried it.
Depends on your broker.

Also with the Oil ETNs/ETFs they have other investments outside of crude oil contracts.
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post #7 of 14
3/12/09 at 3:19pm
Quote:
Originally Posted by Crazed98 View Post
Depends on your broker.

Also with the Oil ETNs/ETFs they have other investments outside of crude oil contracts.
yes they have to, to be able to offer 2x % movements.
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post #8 of 14
3/12/09 at 5:34pm
Good video explaining this point:

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post #9 of 14
3/12/09 at 5:48pm
Quote:
Originally Posted by StockJock-e View Post
Good video explaining this point:
great video this things are a great 1 day trade but a buy and hold is a death trap
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post #10 of 14
3/12/09 at 7:16pm
Quote:
Originally Posted by StockJock-e View Post
Good video explaining this point:

I don't understand what he is trying to get at with the video.

A $100 stock, that travels up 10%, then down 10%, would also accumulate a small loss. I don't understand how this would make an ETF any different than a stock performing in the same manner.
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post #11 of 14
3/13/09 at 12:43am
Thread Starter 
I'm sorry, but maybe my thinking is flawed.

Isn't it so obvious to short one of these leveraged ETFs and in the long-term profit from the volatility decay??

BETTER YET, why dont you just short both an ultralong/ultrashort ETF that track the same index and just profit from the volatility decay?

It seems like easy and free money.
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post #12 of 14
3/13/09 at 1:11am
etf's are only good for one thing and one thing only and that is to day trade them. of course if you have a crystal ball or you are a fortune teller and can tell tomorrow's direction ahead of time then by all means be my guest and may you prosper beyond your wildest dreams.
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post #13 of 14
3/13/09 at 1:34am
Thread Starter 
Can someone tell me if my thinking is flawed or not??
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post #14 of 14
6/5/10 at 6:30am
These leveraged ETFs are designed to deliver the doubling or tripling on a one-day basis. Each day is a separate situation completely distinct from any other day. Whether or not the target doubling or tripling will occur over the course of a multi-day holding period is "path dependent." As the benchmark moves along zigging and zagging day to day, the daily gains and losses are computed with reference to different starting points and the overall multi-day return will depend on the nature of the path from start to finish. This is regarded as somewhat "fine print" in the prospectus. The ETF's can not in most cases meet the benchmark 100 percent of the time leaving differences in the target and the benchmarks. These scenarios are more profound on volatile trading days.
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