Is there Time Decay for Ultra ETFs?

Discussion in 'ETFs' started by jz3384, Feb 3, 2009.

  1. jz3384


    I am curious to know if there is time decay associated with Ultra (bull) ETFs. I understand the tracking error associated with these ultra ETFs due to volatility: if the underlying index declines 10% in a day, then for a 2x Ultra ETF it would decline by 20%, so it would only take a 11% gain for the underlying index to break even but it will take a 25% gain for the 2x Ultra ETF to break even. However, I don't consider this as "time decay". I looked at the daily holdings of Proshares Ultra ETFs and it seems they use swaps to achieve the leverage. Is there "time decay" associated with SWAPs as is the case with options? I also looked into their fund prospectus and time decay is not mentioned as one of the risks.
  2. I'll try to answer as best I can - Hopefully the Mods/Admins will move this to the ETF section.

    The "time decay" you are asking about is the result of daily compounding on the NAV. Just as you describe, a 10% decline on $10 puts you at $9, a 10% rise on $9 puts you at $9.90, over time prices will errode, decay, etc.

    This is VERY different from options decay. Swaps do not decay either. The only place you will see the effects of compounding increase is instances where tracking error compounds the leverage, but then it still has nothing to do with swaps or any of the investment instruments losing value of any kind. These are daily beta funds or daily exposure funds so there is no extended time period where decay might happen. If the ETF has $100mm today the advisor will go out and get $200mm market exposure, tomorrow they repeat the process.

    Does this answer your question?
  3. sumosam


    are CDS used in leveraged funds?
  4. There are none used in the 3x ETFs or our mutual funds. I can't speak for certain about the other leveraged products out there.
  5. sumosam


    ths. sounds like the leveraging is achieved thru options/futures?
  6. I don't know the specific rules that apply to the 2x ETFs but in the 3x the bull funds have to be 80% invested in stocks 300% exposure - 80% stocks leaves 20% cash to get 220% exposure.

    the 3x ETFs use swaps mainly but also futures and options. This is precicely why people like trad3r have no idea what they are talking about when mentioning rumors of 4x and higher ETFs.

    The 20% cash is 11:1 in swaps to get 220% in swap + 80% in stocks = 300%. if you were to be 4x there are several unknowns... first of which is the SEC could (and probably would) require a higher percent to be invested in stocks. but without knowing, if you apply the same model as the 3x, you'd have 80% in stock and 20% to get 320% exposure. that's 16:1 leverage in swaps which crazy - futures would be cheaper and it would be hard to post collateral/margin.

    to answer the question the 3x ETFs use swaps on the index and use futures and options to cover trading costs and true up small differences.
  7. There's no time decay.

    However there are the management fees.
  8. What do you mean? Many seem to believe that the gross annual management fees are taken out daily - this is not the case. Fees are accrued for daily so take the management fee, divide by the basis (# of days) and that will be your daily rate taken overall from the fund.

    a fund with a 1% management fee on a 360-day basis will accrue 0.000027778% per day from the fund.

    3x funds charge 0.75% management fee on a 365 day basis. That means that the fund accrues 0.000020548% on a daily basis for management fees. That's $20.55 per million, per day.

    My numbers may be slightly off due to rounding but you get the idea.
  9. Bolts


    There's a ton of dogma floating around about the leveraged ETF's. Much of it based on certain assumptions about how these funds are "supposed to" behave in theory and how they are managed. If the dogma were true, anybody could make a killing shorting these things. I don't believe it. Each one is managed differently and some track much better than others. Some show no historical evidence of volatility induced tracking errors.
  10. Please give me an example of a leveraged ETF that doesnt suffer from volatility induced tracking errrors.
    #10     Feb 9, 2009