Menu

Monday, January 10, 2011

What if S&P 500 lost 50% on a single day?

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?

4 comments:

  1. 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.

    ReplyDelete
  2. I know, but what would happen to the ETF itself? Will it go to zero that day and 'self-destruct'?

    ReplyDelete
  3. Yes, I believe that the ETF would no longer have any assets. It would be worthless.

    ReplyDelete
  4. I 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%

    ReplyDelete