Most of us know that there are leveraged ETFs, providing up to 3x daily exposure, in decimal percent. Usually these etfs perform just as advertised, but imagine a situation where the index looses a very large portion (~50%). Such an event unlikely, but is not impossible if you think about the 'fat tails' and ~20% loss on black monday in 1987.
Now imagine you are unfortunate enough to own one of the 3X leveraged etfs on while S&P looses 50% of its value. will 3x exposure result in a 150% loss??? Ok, you probably will face a margin call before that, but I'm having a hard time trying to imagine what would happen to the leveraged etf price on such a day.
What do you think?
You can't lose 150%. There's an "implied zero put" in the ETF, which is a small advantage versus trading the underlying strategy yourself.
ReplyDeleteI know, but what would happen to the ETF itself? Will it go to zero that day and 'self-destruct'?
ReplyDeleteYes, I believe that the ETF would no longer have any assets. It would be worthless.
ReplyDeleteI think the ETF value will neither go to negative nor go to zero. Perhaps it is easier to think this way: the 50% drop of S&P will not happen in one tick, suppose it happens in 10 ticks with each tick dropping 6.7% because (1-6.7%)^10=50%. The 3X ETF will drop 3X6.7%=20% each tick, therefore overall ETF comes to (1-20%)^10=10.7%
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