Prep for 2022-Indexes vs 3X Indexes - Investment Magic!

According to the latest (Sep 2021) SPIVA Index Scorecard 70% of all active managers could not beat the S&P500 Index. Other studies show that managers who DO outperform have "below random" returns in the following three years. To nail the point, of the "Top 250 Mutual Funds" listed in this weekend's (12/24/2021) Wall Street Journal, only 7 beat the Vanguard Admiral S&P 500 mutual fund. 8 (other index) funds matched it.  This is obviously NOT a representative sampling but it was good enough for the Wall St. Journal. 

So we get it, the original Malkiel and Bogle (buy the earliest editions you can find) were right all along (as if the success of Vanguard hasn't proved it for a generation!) buy and hold the index fund. It's a heck of a good portfolio!

Index ETF or 3X ETF?

Anticipating a buy on the year-end close this Friday December 31st and hold for all of 2022, this post compares, mainly, the risks, of holding the major index ETFs versus their 3X ETFs. 

Why ETFs? Well, while they are closed in the after-hours, unlike the index futures, they cannot trade outside normal market hours. After LONG history we have to agree that the lack of trading ability is a GOOD thing, an EDGE, for any investor.

Futures also have expirations and, perhaps, rolls which ETFs do not have. You CAN buy and hold an ETF for years with NO taxable event until you sell. Futures mark to market every year.  

What about your thirst for leverage? You can buy ETFs on margin or you can buy 3X ETFs outright with no margin costs - how they do that is magic.

Using Yahoo's full year daily historical data for the SPY and QQQ outright ETFs and the SPXL and TQQQ 3X ETFs since inception (note the TQQQ did not trade until and could not be compared until 2010), we get the following results:

SPY = SPDR S&P 500 ETF Trust (SPY)

QQQ = Invesco QQQ Trust (QQQ) 

SPXL = Direxion Daily S&P500 Bull 3X Shares (SPXL) 

TQQQ =ProShares UltraPro QQQ (TQQQ) 

Drawdown = (Yearly low/yearly high) -1

Return = (Ending price - starting price) / starting price

Start date = Last trading day each prior year.

End date = Last trading day of each year.

2021=Year-to-date as of the close on 12/23/2021

Source: Yahoo Finance

The SPY average return 2011 - 2021 was a remarkable 17%!  Although, SPY's worst drawdown within any given year was Covid's 2020 -41% decline. The 3X SPY, SPYXL average return was 48%, HIGHER than 3 times the SPY. Oddly enough, the worst SPXL drawdown was -73%, significantly better than 3 times -41% or -123% from a multiple position in the SPY. As far as SPY goes, the 3X ETF is signifcantly BETTER!

For the QQQ, the TQQQ average drawdown of -20% is WORSE the QQQ's -26% forget about the multiple. The average returns, though, were as expected.  Given the above results, with an eye to the 2020 worst declines, there appears to be NO advantage to owning the outright ETFs. 3X ETFs do the same or better on paper.

What about the mechanics of my hypothetical $100,000 investment on the 12/31/2021 close?

Investing

The following compares characteristics of buying the above One X and 3X ETFs:

See the magic. How does buying 3X and arguably NINE TIMES the return COST LESS and RISK LESS than buying the 3X on margin*? Note also, somehow buying 3X ETFs increases your exposure with no debt and no chance of margin calls. Finally, note that the exposures are NOT exact. The $47,000 invested in 100 SPY at 10% earns $4700. The $13,967 at 30% earns "roughly" the same. 

And yes, your risk of loss IS great, SPXL and TQQQ drewdown -73% and -59%, respectively, but you paid cash and can carry the position through the decline with NO margin calls. Loading up on 300 shares each of the SPXL and TQQQ will guarantee a wild ride with only your original $100K at risk.

*At my broker, 3X ETFs are virtually not marginable, so you HAVE to pay cash.  An unnamed risk here, the TRUE  unmentioned risk, is what if the 3X ETFs default? Or get delisted? This happened to select volatility and commodity instruments but none with the history/pedigree of SPXL and TQQQ.  Also, I had to revise this post because my drawdown numbers were slightly off and they are now corrected. :-)

Disclaimer: Posts are for education only, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors. Send request to gdrahal@outlook.com to follow this blog and for additional information. 

© 2021 George Rahal.

They're BAAACK!

 Annuity hucksters are back with more style and less substance than ever.

Under the rubric of "Defined Outcome" you get anything but. Correction: some of your losses ARE defined by the huge unecessary fees you pay to put on such a ridiculous strategy. 

Index-linked annuity advertisements creep up like weeds whenever the stock market falls.

I believe these ads mislead and are harmful to your wealth. The above is a rough picture of the investment portion of a one year index-linked annuity contract. These expensive and opaque insurance contracts generally offer, for a 1 year or other term, a certain amount of "buffer" or "shield" from market declines along with a capped share of the gain if the market rises.

This "insurance" strategy can easily be created with exchange traded index options with total transparency, total liquidity, at extremely low cost with NO withdrawal fees and a far smaller cash deposit than any insurance purchase. 

The SPY, S&P 500 ETF, chart above shows the profits and loss from a "split strike with short put" options strategy.  It's something like the "split strike" strategy touted by Bernie Madoff but without the upside.  Whether Madoff is a tip off or not, this is the terrible strategy:

As of last night's (12/22/21) closing prices, with SPY at 470, (1000 shares = $470,000),
Buy 10 SPY 12/16/2022 (1-year) 470 (at-the-money) Puts for roughly $39.20 or $39,200
Sell 10 SPY 12/16/2022 (1-year) 420 (10% out-of-the-money) Puts for $23.875 or $23,875
Sell 10 SPY 12/16/2022 (1-year) 520 (10% in-the-money) Puts for $65.155 or $65,155

These trades combined will CREDIT your options account with +$49,830.
Total commissions at my broker for these trades are $20.85. 

The initial margin required for the 10 lot position according to my broker today is $116,510.

This is fully covered by your 1000 share long position which is the "reason" you are putting this hedging strategy on in the first place. 

With options you have full transparency with market prices available anytime the market is open.

You have total control! You can get out ANYTIME for the same $20.85 commissions.

There are NO withdrawal fees, no waiting periods, no hassle at all to get in or get out!

This $49+K credit is the "protection" against the loss of your real portfolio, which in this example, is the $470,000 invested in the SPY.  This example is slightly more than 10% but you can change your credit by adjusting the strike prices of your options.

Why is this strategy so bad? Look at the chart: your losses can be UNLIMITED and your gains are capped, the exact opposite what any investor wants. If you really do want protection, forget selling puts and just buy the at-the-money put. The "married put" is a pricey insurance policy that costs 11% of your portfolio and gives you total protection from the downside with 100% upside (except for the insurance premium) if the SPY rises.

The chart above is so bad that option traders don't even sell this strategy. You would be hard pressed to find the above options payoff chart online.  Its so bad that only annuity salesmen would sell it.

Feel free to post comments.

Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.

11 Trading Days Left in 2021

As the year turns, its time to prepare for the last trading day of 2021 and especially the 2021 year end close at 4PM* Friday December 31st!  Let's look at how my hypothetical Model Account in 2021 went:

This was obviously a lucky year.... or was it? Let's look the same trade in the extreme year of 2020.

Not such a good year. The $100K model account lost ALL its value, and then some, in the Covid March break and had to post maintenance margin (totalling $40+K, not shown). The true believer though ended up with a net double ($100K gain) at year-end.

What about a more "normal" year, like 2019?

In the first half, the model account was up $50K, stayed unch until November, and then rose another $50K, posting a $100K gain for the year. 

So WHAT IS? this model account that has SO much risk yet apparently so many gains. Its simply a small variation on the long stock index buy and hold-but with the leverage of futures. Short answer: just look at the S&P and Nasdaq charts!

ES and NQ Buy and Hold

This is a hypothetical futures account, funded with a hypothetical $100K, that hypothetically buys, on the last day of the year, at the close, one "red" March S&P 500 E-mini futures and one "red" March Nasdaq 100 E-mini futures contract. The initial margin requirement for this position is today roughly $40,000. You post $100K, so you have $60,000 margin excess ($60K losses before you get a margin call).

As I write, noonish December 16th, 2021 the "red" March 2023 S&P 500 E-Mini, symbol ESH23, is offerred at 4740.00 and the "red" March 2023 Nasdaq 100 E-Mini, symbol NQH23, is estimated at 16,000. Both contracts should have firm offers by the December 31st last trading day of the year. 

At current pricing, ESH23 has a notional value of (4740 x $50=) $237,000. And the NQH23 is at (16,000 x $20)=$320,000. Being long at these prices would give ($237,000+$320,000)=$557,000 of index exposure (read risk) in your futures account. 

My broker's current initial margin requirement for the S&P E-Mini is about $16,000 and the Nasdaq E-Mini is $24,000. Thus the total margin requirement for this hypothetical account is roughly $40,000. The $100K deposit would leave an excess of $60,000 in the account.

Outlook

2022 appears to be a pivotal year with the first signs of inflation, the hyper politics of the mid-term elections and the twists and turns of the Covid pandemic. But we have HAD many pivotal years, especially in the Covid infected 2020. So 2022, despite all the hemming and hawing, may just be another year in the market. 

Happy Christmas, Happy 2022 and Happy Trading!

*"Red" means, in commodity talk, the next year's month not the upcoming month. Thus, today's "red" March means March of 2023, not the upcoming 2022. The March 2023 contract is nearest contract to trade during the entire year 2022. There are many details involved in the reasoning behind this kind of trading account. For more complete information showing markets and returns feel free to download my spreadsheet here. Note also, these are hypothetical accounts only.  

Disclaimer: Posts are for education only, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors. Send request to gdrahal@outlook.com to follow this blog and for additional information. 

© 2021 George Rahal.

Commodities Dinged but Still UP 20% YTD in November

Just as inflation panic began to spread, commodity prices solidly fell -7% in November while holding strong +20% gains year-to-date.

GSCI=S&P GSCI Commodity Excess Return Index

BCOM=Bloomberg Excess Return Commodity Index

The declines were widespread as the following table of the BCOM components shows:

The biggest gainers were energy. Note precious metals and a few agriculturals are down on the year. Note also crudes gave up substantial gains in November.

*Excess Return indexes are futures price returns without the interest on futures collateral included in Total Return indices,

Disclaimer: Posts are for education only, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors. Send request to gdrahal@outlook.com to follow this blog and for additional information. 

© 2021 George Rahal.