The Evil 2x Leveraged ETFs
by Tony on Dec.16, 2008, under The Gooch
There seems to be a lot of confusion regarding how double inverse ETFs work. Many of them make no sense but there is a good reason for all of this. For example, FXI is down 50% year to date and FXP is supposed to track 2x the opposite of the performance of FXI. One would think that since FXI is down 50%, FXP would be up 100%, right? Actuall, FXP is also down 50%. There are 2 reasons for this: The first is that the price of the double inverse ETF is adjusted on a daily basis, so lets assume the following parameters and run a quick test:
Day 1: FXI and FXP = 100
Day 1-10: FXI goes down 5% per day
Day 11-19: FXI goes up 10% per day, Day 20: FXI goes up 8%
As you see below, by day 20, FXI is back to 100 while FXP is down 14% at 86. The second reason is that if FXI is down 75% hypothetically, from 100 to 25, FXP would go from 100 to 250. Then if FXI increases 50% from 25 to 38, FXP would theoretically be down 100% from 250. So the moral of the story is that every double inverse and triple inverse ETF will be liquidated and worth zero when the market rebounds. This may not happen for a while, but UYG is a perfect example of a double long ETF that was close to liquidation due to the quirky math. UYG tracks 2x the performance of the financials index (XLF; it is the opposite of SKF). These ETFs make excellent trading vehicles on a daily and weekly basis, but if you have a long term view on something, your best bet is to use options or the underlying index (long or short).
Hope this was helpful.
| Day | FXI Return | FXI | FXP Return | FXP |
| 1 | -5% | 95 | 10% | 110 |
| 2 | -5% | 90 | 10% | 121 |
| 3 | -5% | 86 | 10% | 133 |
| 4 | -5% | 81 | 10% | 146 |
| 5 | -5% | 77 | 10% | 161 |
| 6 | -5% | 74 | 10% | 177 |
| 7 | -5% | 70 | 10% | 195 |
| 8 | -5% | 66 | 10% | 214 |
| 9 | -5% | 63 | 10% | 236 |
| 10 | -5% | 60 | 10% | 259 |
| 11 | 5% | 63 | -10% | 233 |
| 12 | 5% | 66 | -10% | 210 |
| 13 | 5% | 69 | -10% | 189 |
| 14 | 5% | 73 | -10% | 170 |
| 15 | 5% | 76 | -10% | 153 |
| 16 | 5% | 80 | -10% | 138 |
| 17 | 5% | 84 | -10% | 124 |
| 18 | 5% | 88 | -10% | 112 |
| 19 | 5% | 93 | -10% | 100 |
| 20 | 8% | 100 | -16% | 84 |
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December 16th, 2008 on 3:27 pm
Very helpful.