Leverage your roundtrip investment

The family of Leverage Shares ETPs is growing. As of April 14th, two new products tracking Tesla, Inc’s common stock have commenced trading on Cboe Europe; hence, additional leveraged tools are now at the disposal of investors.

Leverage Shares 2x Tesla ETP (TSLA2X:IX) seeks to track the iSTOXX Leveraged 2X TSLA Index, which is designed to provide two times (2x) the daily leveraged returns of Tesla. The ETP is physically backed by the direct purchasing of the underlying stocks, like all Leverage Shares ETPs.

However, the biggest news is the first short ETP of the series:
Leverage Shares -1x Tesla ETP (TSLASX:IX) seeks to track the iSTOXX Inverse Leveraged -1X TSLA Index, which is designed to provide -1x the daily leveraged returns of Tesla. The ETP is backed by holding the short positions in the underlying Tesla stock and the resulting cash balances.

As usual, these newly listed exchange-traded products are based on shares of globally recognized companies. The news of the Tesla ETPs is even more exciting, for a number of reasons. Over the last few years, climate change has mushroomed into a worldwide concern and people are increasingly sensitive to environmental issues. Tesla, an American electric vehicle and clean energy company, is now a brand recognized for challenging the status quo. Led by a visionary CEO known for his infamous antics, Tesla’s efforts for establishing a purely electric brand in an industry notorious for its huge barriers to entry is commendable. Nevertheless, the initial venture capital was heroic and Tesla’s growth has been supported via continued access to capital (issuing new shares or taking on additional debt), instead of via earnings. However, the growth in that industry is easily predictable and electric vehicles are the future of mobility.

Over the last months, the exponential rise of its stock price has pushed Tesla’s market cap past $100bn, surpassing even that of Germany’s Volkswagen, the world’s biggest carmaker in terms of volume. The following chart shows Tesla’s price development from 2012 to mid-March 2020:
So how much is Tesla really worth?
There is no doubt that the company has an early adopter advantage, particularly considering traditional carmakers, which are yet to come up with anything similar, albeit their competitive edge. Yearning investors can refer to the hundreds of lengthy reports available on the firm, as this article does not aim to advise or recommend any investments. We want to focus on how Leverage Shares ETPs can be valuable tools to leverage and complement investment strategies and convictions. Tesla shares have exhibited extreme volatility throughout the years, an annualized average of approximately 50%.
In the chart above we have limited the analysis, for empirical purposes, to the last two years. The choppy trend has given traders numerous chances to prove their talent. Leverage Shares has now made available these two exchange-traded products, enabling quick and enhanced execution of daily investment strategies, whether long (via the 2x ETP) or short (via the -1x ETP). Regardless of their view, investors can now ride the next swings of the market with efficient leveraged support in both directions. In this paper, we want to look beyond the short-term and exhibit how leveraged ETPs may also be used to take a strategic position on a share. The opportunities to exploit intervals of huge price moves have not been missed, for both traders looking for a quick bet, and for investors keen on magnifying their buy-and-hold strategies based on Tesla. You can refer to “Beyond the short-run” for the application of Leverage Shares 2x Tesla ETP, given that long 2x ETPs differ only in the underlying share they track. Hereinafter, the focus will be on TSLASX:IX (Leverage Shares -1x Tesla ETP) and the different strategies that we can create going short. Some simple and illustrative examples are set out below.

The hedging strategy
With reference to the same two-year period as before, we have highlighted the steep price drops in red. The numbers 1 (March 2018), 2 (June 2018) and 3 (August 2018) portray three extreme (and similar) drawdowns. The duration of each decline varied between two and four weeks, the negative returns ranged from -22% to -30%, whereas volatility remained in line with its average value. Obviously, everything appears clear once analysed in hindsight. Strong conviction trades often require sophisticated tools – or alternatively, the use of derivatives. This is only exacerbated when investors aim to gain a short exposure, as the number of investment vehicles at their disposal is even more limited. A listed and physically backed product designed to provide the daily inverse returns of the underlying may be just what the doctor ordered. When short selling is an isolated bet and considered in a vacuum, there are no exceptional scenarios to contemplate. The investor only hopes that his predictions play out as planned. However, when going short aims to hedge an existing buy-and-hold strategy, or to build an alternative strategy, some pitfalls need to be taken into consideration.

The first one is the opportunity cost, since a perfect hedge requires capital and offers no returns on the position created. Then, an investor has to manage the hedging spread, due to the price difference between the underlying to hedge and the securities employed for that purpose, which often creates a gap. Especially in longer-run strategies, it is important to consider the impact of fees and the effect of compounding, the relevance of which increases over time. The NAV of all Leverage Shares ETPs precisely track the indices of the respective underlying stocks and the influence of the fees can be neglected when an investment strategy runs for a few weeks or months. However, the same cannot be said for the distortions due to compounding interest. The long period of the drawdown highlighted in the previous chart (6 months) goes from the middle of December 2018 to the end of May 2019 and it has been chosen to exhibit this last phenomenon. Tesla dropped more than 50% in that period, with strong and striking volatility.
In the chart above, we hedged Tesla over that period using the hypothetical NAV value of the Leverage Shares -1x Tesla ETP, since historical data are not available yet due to obvious reasons. The difference with the perfect hedging depends on the effect of compounding interest. Compounding is the process whereby interest is credited to a principal amount, yielding interest on interest. In a hedging strategy, the position for hedging undergoes daily returns which are inverse those of the position to hedge, creating a divergence that strengthens as the frequency of compounding increases. An investor needs to periodically adjust the exposure so that it remains equal to the initial leverage, in this case -1x. This is a fundamental rule to get a perfect hedge.
Without these adjustments, like in our example, the initial leverage coefficient moves rapidly far from the starting ratio (graph above), generating undesired distortions. The market-neutral strategy

A market-neutral strategy seeks to profit from both increasing and decreasing prices, while attempting to create diversification and avoiding market risk. A position of 50% long / 50% short on the stock market is neutral, because it is not affected by directional price movements, but only by the performance of two or more securities. When markets are in a risk-on phase, long positions have to grow more than short positions to get a positive yield, while the contrary applies during risk-off periods.

Over the last few years, the correlation between Tesla and the Nasdaq was low, as is visible on the following chart. We have highlighted the six-month drawdown, already seen before, to portray how a market-neutral strategy would have worked.
Leverage Shares -1x Tesla ETP for the short position, combined with an equal-weighted long position on Nasdaq, is an easy example of a market neutral strategy. To reiterate, the NAV price of TSLASX:IX is hypothetical, but rather precise. We have plotted the result in the chart below, using a logarithmic scale:
The sizable return of the strategy is derived only from the spread between the performance of the two positions. In this example, the outcome is magnified by the fact that Nasdaq was quite positive, whereas Tesla depreciated considerably, ensuring gain from both the long and short positions. This is not an attempt to point out a win-win tactic, but rather how an ETP might be employed to design alternative strategies that diversify the sources of risk and return. The volatility of this market neutral strategy was half that of Tesla stock and slightly higher than that of the Index (25% vs 20%), but with the essential decorrelation, we were looking for (-0,19 vs Nasdaq). Nevertheless, some caveats need to be emphasized. First of all, this kind of strategy generally generates both gaining and losing positions. Despite the tax policies are not uniform in the various countries, we can still say that retail investors are rarely allowed to offset gains and losses when operating outside a wrapper investment vehicle. For this reason, retails are not able to take advantage of fiscal counterbalance and this matter has to be considered. Ultimately, compounding interest rate effects work as usual, modifying the ratios of the exposure. The market-neutral strategy that we have just illustrated has not been rebalanced. In the long-run, rebalancing is necessary, but could also be complex and costly. An alternative could be to make adjustments when certain ratios exceed an established threshold.
For the purpose of exhaustiveness, we have adjusted the strategy when the ratio long/short position was +15% or -15% over the initial value of 1. The comparison is plotted in the chart above.

Long/short strategies with Leverage Shares ETPs
Short positions can be used for a variety of long/short strategies, based on different outlooks and convictions. For empirical purposes, in this last paragraph, the intention is to create an alternative strategy based on the current situation, when markets and investors are still traumatized by the COVID-19 pandemic. The crash started immediately after the 14th of February 2020, when S&P500 had reached a level of 3380.16, an all-time high. The collapse caught investors off guard, scrambling for seemingly non-existent safe havens. Nevertheless, once the repercussions of the lockdowns became increasingly apparent, some investment suggestions started to make more sense than others. For example, the growth of Tesla’s stock in the months leading up to the crisis have been so rampant to make profit-taking likely; on the contrary, it would have been beneficial to think about Amazon and Netflix as defensive stocks, as their business model are relatively immune to the imposed quarantines.
History is still being written, but in the chart above, from the peak of February until the Friday 27th March 2020, you can observe the violent drop of Tesla and how Amazon and Netflix held up better than S&P500 Index. What could be a simple strategy using Leverage Shares ETPs in such a situation? A long/short one, for example, where the short side is based on Tesla (TSLASX:IX), and the long is built using two leveraged ETPs that track Amazon (AMZ2:LN) and Netflix (NFL2:LN). Given that the two long ETPs have a 2x leverage, for obtaining a 50% long – 50% short exposure, the strategy has to invest the 66,66% in TSLASX:IX and the 33,34% into AMZ2:LN plus NFL2:LN (equal weighted in this sample).
The comparison between the strategy and S&P500 has been plotted in the chart above, considering both a starting day on 14th February 2020 and two weeks later, on 28th February. The uncorrelated outcome would have been an interesting strategy (or a part of a more complex one) to enhance diversification and curb volatility.

The traditional use of leveraged exchange-traded products (ETPs) is for daily or short-term trading. But, in an increasingly complex market, investors also have to consider unconventional approaches. In the end, it is these challenging times that force investors to push the envelope. In a world where we have more investment choices than ever before, it is up to the investor to gauge his desired result and choose the means of accomplishing it accordingly. Transparent and physically-backed, Leverage Shares ETPs attempt to make that selection process a bit easier. Each time a step forward comes when you grasp the potential of the tools you can have in your hands.