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10-Jun-08
Double Inverse ETFs: Born To Lose
I am going to put to rest these issues surrounding whether double inverse ETFs accurately track the underlying indexes.
Here are the facts:
1. If the underlying index has a daily percentage gain, the double inverse ETF (diETF) will lose twice as much as the underlying index gained.
2. If the diETF experiences a one-day percentage loss, then the diETF can never ever recover to break even, relative to the underlying index it tracks.
Before I show why this is true, there are other issues to clear up. If we are talking about (SRS: 91.45 0.00%), the diETF for the Dow Jones US Real Estate Index, then we must compare SRS historical data to the historical data of the index it tracks, not to the historical data for another ETF, even though it may be tracking the same index. To compare ETFs to ETFs, instead of an ETF to the actual underlying it is tracking, will compound errors.
This experiment will compare SRS, a diETF, to the index it tracks, the Dow Jones US Real Estate Index, symbol DJUSRE.
Historical data for DJUSRE is available from Dow Jones here: DJUSRE Historical Data. Also, if anyone wants to perform more research on this subject, here is the Dow Jones Indexes website: Dow Jones Indexes.
I have pasted the spreadsheet below. I will do my best to explain what it all means.
*Note* Click on the spreadsheet once, and it will open in a new window. In the new window, click it again, and it will open full size.
Column C has the daily percentage changes for SRS since inception. The sum of all daily percentage changes is 51.77
Column I has the daily percentage changes for DJUSRE during the same period. The sum of all daily percentage changes is -26.82
Ideally, 2(-26.82) would equal 51.77. Obviously it does not. We can see already, by summing the daily percentage changes, that SRS did not track the daily percentage changes of DJUSRE exactly, but this is a small error and is likely due to irregularities in maintainging the swaps and futures. This may also be due to management fees.
Next, look at the last cell in column E and K. This number is the percentage gain or loss since inception. We can see that SRS gained 25.39% over the period, while DJUSRE lost 39.04%
Yes, that is correct. It is erroneous to assume that SRS would be +39.04%. It does not track the annualized percentage change of the DJUSRE, only the daily percentage change. Annualized, SRS has 13.65% less than twice the loss of DJUSRE.
Finally, look at rows 15 and 18 in columns F and L. I have highlighted the cells. These calculations show that even over the short term, if the diETF goes down EVEN ONE DAY, IT WILL NEVER EVER BE ABLE TO GET BACK TO BREAK EVEN.
Let me explain. Look at the price changes from February 1 to February 23. During this time period, the DJUSRE value has moved up and down. On February 23, the DJUSRE index is almost back to breakeven. Cell L18 shows that the index has lost 0.71668% from Februrary 1 to February 23.
Now look at SRS during the same period. The closing price of the SRS is actually higher than the inception price, as it should be, since DJUSRE is showing a small loss, right? Be very careful here. While DJUSRE has lost 0.71668%, SRS has only gained 1.3246%, relative to its inception value. If we calculate twice the loss of DJUSRE on that date, we would get 1.43336% Observe that the gain of SRS is less than twice the loss of the underlying index.
From February 1 to February 23, SRS has actually lost 0.10876%, and it will never ever be able to make up that loss. In fact, these losses will compound over time.
These diETF are certainly great to trade on short time frames, but buying and holding them will guarantee losses.
Please, if you have any questions about how this all works, do not hesitate to ask. I hope that now we can put this issue to rest, once and for all. Now that we understand how diETFs are born to lose, I suggest we begin to figure out how to profit from this anomaly.
I would also ask humbly that you link to this post, and pass it around, if you find it helpful. In my estimation, there is no other resource available on the internet that explains this diETF phenonmenon as well as this article.
Tagged Stocks: SRS
Posted at 23:45 in External Blog | Permalink | Top
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2 Comments on "Double Inverse ETFs: Born To L..."
Posted on 11-Jun-08 05:51 by Don_Bartell
Posted on 11-Jun-08 05:56 by Don_Bartell
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