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North America Market Commentary 27 March 2009
Phil Mackintosh
+ 1 212 325 5263
ETF Trade Strategy
Victor Lin
+ 1 617 556 5658 Triple Trouble
$220x2
$220x10%x2 =
$44
$20x10%x2 =
$100x2
$4
$100x10%x2 $20x2
= $20
Pair Statistics
Correlation -0.99
R-Squared 0.98
Beta -0.99
Pair Statistics
Correlation -0.96
R-Squared 0.93
Beta -1.02
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Portfolio & Derivatives Strategy
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Portfolio & Derivatives Strategy
Exhibit 7: UCO (daily reset) vs DXO (monthly reset) Does Reset Frequency Matter?
140.00 Almost all leveraged ETFs currently listed have their leverage reset daily in the
rebalancing process described in this report. However, some ETFs such as
120.00
the PowerShares DXO (2x long crude) are reset monthly. Rather than
100.00
receiving twice the daily return of the underlying index, investors receive twice
80.00 the monthly return. Does this significantly affect returns?
60.00 To compare, we calculate a theoretical 2x leveraged daily reset version of
40.00 DXO. In general, the two have similar performance when volatility is on the
20.00
DXO (Monthly reset) lower side. However, high volatility levels widen the performance differential
UCO (Daily Reset)
Oil Future (front month) between the daily and monthly reset series as it magnifies the effect of
-
leverage and the short gamma exposure described earlier.
11/25/08 12/15/08 1/4/09 1/24/09 2/13/09
Exhibit 8: Daily and Monthly Reset Differences Magnified in High Volatility
Credit Suisse Portfolio Strategy
6 90
4 80
70
Cumulative Spread
Realized Volatility
2
60
0 50
-2 40
30
Exhibit 9: Daily vs Monthly Reset, 2x Long Crude -4
20
140
-6 10
120 S p re a d V o la ti li ty
2x monthly (DXO NAV) -8 0
100 2x daily 6 /1 7 /0 8 8 /1 7 /0 8 1 0 /1 7 /0 8 1 2 /1 7 /0 8 2 /1 7 /0 9
DBOLIX Index Source: Credit Suisse: Portfolio Strategy
80
We show (below, Exhibit 20) an exaggerated example between daily and
60
weekly leverage resets to illustrate how extremely volatility can affect their
40
performance. While it’s unlikely such a scenario would occur, it does show
20 how high volatility and different reset periods can significantly affect returns.
0 Exhibit 10 : Daily vs Weekly Reset Example
6/17/08 8/17/08 10/17/08 12/17/08 2/17/09 Rolling 2 x
2x 2x ETF Weekly Weekly 2x ETF
Credit Suisse Portfolio Strategy
Index Return Return (daily) Return Return (weekly)
100 100.00 100
Day 1 75 -25% -50% 50.00 -25% -50% 50
Day 2 63 -16% -32% 34.00 -37% -74% 26
Day 3 61 -3% -6% 31.84 -39% -78% 22
Day 4 51 -16% -33% 21.40 -49% -98% 2
Day 5 100 96% 192% 62.53 0% 0% 100
Source: Credit Suisse: Portfolio Strategy
Exhibit 11: DXO Underlying Diverges from UCO Underlying Underlying Matters Most!
160 So does the reset frequency explain the difference in performance between
140
the monthly reset DXO and the daily reset ProShares UCO that many
investors have noted recently?
120
100 It does partly contribute, but in this particular case, it’s the benchmarks that
80 are more responsible for the difference than the reset period. As with all
60
ETFs the underlying benchmark can be very important. Especially for futures
DJAIGCL (UCO Underlying)
based ETNs, used in many crude oil ETFs, the roll treatment and calculation
40 DBOLIX (DXO Underlying)
can, in fact, be quite different.
20 WTI Crude Front Mo. Future
0 While both DXO and UCO track crude futures based indices, DXO tracks the
1/2/08 3/2/08 5/2/08 7/2/08 9/2/08 11/2/08 1/2/09 Deutsche Bank Optimum Yield Crude Oil index while UCO tracks the Dow
Jones-AIG Crude Oil sub index. The two had been tracking closely, but have
Credit Suisse Portfolio Strategy
recently diverged – the primary reason being that the indices use different
rules which may result in the selection of different expiration contracts or
rolling futures at different times.
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Portfolio & Derivatives Strategy
Long Term Holders note: Good in Momentum, Bad when Volatility Rises, or Markets Turn
By simulating specific market regimes, we can more clearly illustrate the risks & benefits of holding a leveraged ETFs.
Exhibit 13: Good in Trending Markets Exhibit 15: Bad thru Market Cycles Exh 17: Range Bound & Volatile Market
ULTRA-SHORT ULTRA-SHORT
$330 $200 ULTRA-SHORT
$150
$180 -SPY
-SPY SPYx-2
$280 $160 SPYx-2
SPYx-2 -SPY
Share Price
$140 UltraShort
Share Price
$125 UltraShort
UltraShort
Share Price
$230 $120
$100
$100
$180 $80
$60
$130 $40 $75
$20
$80 $- $50
0 140 280 420 560 700 840 980 112012601400 0 140 280 420 560 700 840 980 1120 1260 1400 0 140 280 420 560 700 840 980 1120 12601400
Days
Exhibit 14: Good in a Trending Market Exhibit 16: Bad thru Market Cycles This shows that Leveraged ETFs:
ULTRA LONG
$430 $200
ULTRA LONG
Work well in a trending market as
$380
SPY
$180 momentum and compounding can
SPY
$330 SPYx2 $160
SPYx2 combine to produce significant
Share Price
Share Price
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Portfolio & Derivatives Strategy
3.5
1% Volatility 10% Volatility
3
20% Volatility 40% Volatility
60% Volatility 2 .5
2.5
2 2 .0
1.5
1 .5
1
0.5 1 .0
0
0 .5
short 2x short 3x
0.8
-50% Long Spread
Short Spread
In such a high volatility environment, derivatives such as futures, swaps, and
0.6
-100% Volatility options may be better suited for investors looking for leveraged exposure over
0.4 a longer time horizon.
-150%
0.2 In lower volatility regimes, the differences between leveraged returns should
-200% 0 be less significant.
12/9/98 12/9/00 12/9/02 12/9/04 12/9/06 12/9/08
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Portfolio & Derivatives Strategy
-6%
20
-8%
-10% 0
1/2/2008 4/2/2008 7/2/2008 10/2/2008 1/2/2009 1/2/2008 5/2/2008 9/2/2008 1/2/2009
S&P 500
Functionally, triple leveraged ETFs work the same way as double leveraged
2x ETFs with the obvious difference being that leverage, and consequently
3x
volatility, is increased. As leverage increases, return distributions become less
peaked and fatter tailed, meaning a higher frequency of large moves.
-0.10 -0.05 0.00 0.05 0.10 0.15 Additionally, as previously discussed, a 3x ETF will effectively increase
volatility by at least a factor of 3, leading to a more heavily skewed long-run
Credit Suisse Portfolio Strategy
lognormal distribution.
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Portfolio & Derivatives Strategy
Exhibit 25: S&P Intraday Volatility High at Open/Close Are Leveraged ETFs Increasing Close Vol?
3.0%
Jul-08
As we highlighted in our report, Intraday Rollercoaster Rides: Market Moves at
Day’s End, in late 2008 closes became very volatile and difficult to trade.
30-min Intraday Price Movement
2.5% Aug-08
2.0%
Sep-08
Oct-08
There was some media speculation that leveraged ETFs were a big
1.5%
Nov -08 contributor. We think this was overplayed:
Dec-08
1.0%
Jan-09
Feb-09
1. Leveraged ETFs are less than 2% of end-of-day trading
0.5%
As we showed earlier, leveraged ETFs need to trade into the close to realign
their exposure appropriately for the following day’s open. We estimate that
0.0%
this rebalancing accounts for less than $1.5 billion (see sidebar), while around
9:30
10:30
11:30
12:30
13:30
14:30
15:30
$70 billion trades in the last half-hour based on our calculations, leveraged
Credit Suisse Portfolio Strategy
ETFs are only a very small percentage of that ($1.5 billion / $70 billion =
2%).
Average daily amount of rebalancing required Exhibit 26:
( Closing
) Volumes Likely Dwarf Leveraged ETF Rebalancing
for leveraged ETFs: ~ $1.4 billion 8%
A v erage D aily V o lume C urv es O v er T ime (S & P 5 0 0 )
1 0 :0 0
1 0 :3 0
1 1 :0 0
1 1 :3 0
1 2 :0 0
1 2 :3 0
1 :0 0
1 :3 0
2 :0 0
2 :3 0
1 :0 0
3 :0 0
2:0 0
1 2 :3 0
3 :3 0
2:3 0
1 2 :0 0
4 :0 0
3:0 0
1 1 :3 0
3:3 0
1 1 :0 0
4:0 0
1 0 :3 0
1 0 :0 0
9 :3 0
Total amount of trading in the last 30 min: c2t -0008 6 - 2N0o0v 7- 0 8 J uDl-e0c 8- 0 8 A uJ agn- -0089 FSeebp- 0
- 09 8 O ct-08 N ov -08 D ec -0 8 Jan-0 9 F eb-0 9
~$70 billion
Source: Credit Suisse: Portfolio Strategy
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Portfolio & Derivatives Strategy
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Portfolio & Derivatives Strategy
CS may, from time to time, participate or invest in transactions with issuers of securities that participate in the markets referred to herein, perform services for or solicit
business from such issuers, and/or have a position or effect transactions in the securities or derivatives thereof. The most recent CS research on any company mentioned is at
http://www.csfb.com/researchandanalytics.
Backtested, hypothetical or simulated performance results have inherent limitations. Simulated results are achieved by the retroactive application of a backtested model itself
designed with the benefit of hindsight. The backtesting of performance differs from the actual account performance because the investment strategy may be adjusted at any
time, for any reason and can continue to be changed until desired or better performance results are achieved. Alternative modeling techniques or assumptions might produce
significantly different results and prove to be more appropriate. Past hypothetical backtest results are neither an indicator nor a guarantee of future returns. Actual results will
vary from the analysis.
Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, expressed or implied is made regarding future
performance. The information set forth above has been obtained from or based upon sources believed by the trader or sales personnel to be reliable, but each of the trader or
sales personnel and CS does not represent or warrant its accuracy or completeness and is not responsible for losses or damages arising out of errors, omissions or changes in
market factors. This material does not purport to contain all of the information that an interested party may desire and, in fact, provides only a limited view of a particular
market.
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