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Basket Trading: An ETP Approach

Your capital is at risk if you invest. You could lose all your investment. Please see the full risk warning here.

It’s obviously difficult to know which company within a particular sector or theme is going to be the champion performer over time. When in doubt, an investor can always build a “basket” of single-stock ETPs around a theme in order to get non-diluted exposure for a particular trading strategy.

In this article, we’ll take a quick look into the ideas of “baskets” and present a number of moments when baskets built with Leverage Shares ETPs have shown strong performance.

 

Basics of Basket-Building

A “basket’ is simply a collection of instruments that are traded simultaneously. The concept is familiar for investors who have previously invested in ETFs, which often provide exposure to a broad basket of stocks. Creating more targeted exposure via smaller baskets allows investors to choose their own investments rather than investing in (too) many products, some of which may not not necessarily ‘belong’. It’s a particularly important tool for institutional investors and investment funds looking to hold multiple securities in certain proportions since simultaneous trades hold in place the portfolio allocation for each security.

It’s not particularly difficult for investors to conceive and build a basket: all that’s needed are a few building blocks to crystallize an idea.

The “first block” would be the type of security. In the examples we present here, the securities we use will be our 3X long ETPs available for sophisticated investors.

The “second block” would be the rebalancing frequency, i.e. how often would the ETPs be held before being rebalanced to the target exposure (equal weighted, market cap weighted, custom weighted, etc.)? In the examples we present here, since the standard recommendation is that leveraged instruments shouldn’t be held for more than a day, we shall set the basket rebalancing frequency at “daily”.

The “third block” would be the invested amount. In the examples we present here, we make an initial investment of $10,000 and then use the proceeds to finance subsequent rebalancing.

The “fourth block” is the allocation rule, i.e. in what proportion are the 3X ETPs to be held? In the examples we present, the allocation rule would be equally-weighted. The closing price of the day would determine the weight of each ETP held.

The “final block” would be the basket’s theme. This is the central idea behind the investor holding the ETPs in question. Each of the examples we present will be based on a different idea previously presented in Leverage Shares’ “Market Insight” section over the past few weeks.

Throughout this article, two benchmarks will be used: the tech-heavy Nasdaq-100 (NDX) and the broad-based S&P 500 (SPX). The holding period for each basket will be a minimum of one calendar month.

 

Exploring Themes

The first theme we’ll outline is the “Gig Economy” which – as highlighted in an earlier article – feature heavy-hitters Airbnb and Uber. As the global economy recovered from the pandemic in Q1 2021 and lockdowns eased, it would be a fair assumption that these two stocks might do well.

In the calendar month of February 2021, the basket of 3X Airbnb (ABN3) and Uber (UBR3) ETPs reached a performance of over 60% before closing out the month with a net 12% in gains. The benchmarks NDX and SPX were down 3% and up 0.9%, respectively.

Websim is the retail division of Intermonte, the primary intermediary of the Italian stock exchange for institutional investors. Leverage Shares often features in its speculative analysis based on macros/fundamentals. However, the information is published in Italian. To provide better information for our non-Italian investors, we bring to you a quick translation of the analysis they present to Italian retail investors. To ensure rapid delivery, text in the charts will not be translated. The views expressed here are of Websim. Leverage Shares in no way endorses these views. If you are unsure about the suitability of an investment, please seek financial advice. View the original at

The next theme will be “Streaming”, which is shaking up traditional broadcasting and cable services. As we discussed in our article on streaming companies, it might be premature to include Disney in this category yet. So this basket has the 3X Netflix (NFL3) and Roku (ROK3) ETPs.

The calendar month of June was particularly interesting here: the ARPU (Average Revenue Per Unit) numbers and estimates for Q2 2021 were released by the companies along with many industry experts and watchers making prognostications of what the financials as well as the ARPUs signified.

Over the calendar month of June 2021, after a period of uncertainty, the basket closed with over 57% in gains. The benchmarks NDX and SPX were up 6.6% and 2.2% respectively.

Seasoned investors will likely know that “FATANG” – Facebook, Apple, Tesla, Amazon, Netflix and Alphabet – are a popular basket of stocks that generates a lot of discussions among day traders, punters and financial media.

2020 was a trying year for these stocks. After the drop in February to the highs in subsequent months, Q3 2020 started out with a warning from many analysts that these stocks were outsized in their prices which led to another drop that quarter. However, these stocks persevered on the basis of strong earnings and other metrics.

In the calendar month of November 2020, the basket of 3X Facebook (FB3), Apple (AAP3), Amazon (AMZ3), Netflix (NFL3), Alphabet (GOO3) and Tesla (TSL3) ETPs yielded 24% in gains while the benchmarks NDX and SPX yielded 10.6% and 9.4% respectively. Continuing to “run” the basket till the end of December would have yielded 37% in gains while the benchmarks yielded 16.3% and 13.5% respectively.

Caveats and Conclusion

Hindsight is always 20/20 so a look back would yield many such opportunities for various “long” themes. However, a shrewd investor can modify the idea of baskets in many ways to yield opportunities even during market downturns.

For instance, if the “third block” were amended such that the invested amount remains capped at $10,000, i.e. regardless of the day’s performance, the investor were to top up the investment amount and remained invested, a “modified inverse” FATANG basket – -1X Facebook (FBS), Apple (APLS), Amazon (AMZS), Netflix (NFLS) and Alphabet (GOOS) and the -2X Tesla (TS2S) ETPs – would have yielded 17% in gains for the calendar month of February 2020 while the benchmarks were down 7% and 9% respectively. This might prove to be an effective way to short these stocks, or even simply hedge exposure to the likes of the Nasdaq-100.

Readers should notice that this “modified inverse” basket even amended the “first block” in another way: the same inverse factor was not used for all companies since there was an expectation that Tesla would be hardest hit on account of lockdowns, et al. This is an important distinction: it’s not necessary to pick only leveraged instruments. To complete a theme, an investor can add Leverage Shares’ range of 1X Stock Trackers and/or select combinations of 3X, 2X and -1X factors with different (or even the same) underlying companies to build out interesting strategies. In other words, the “final block” could determine what the first through fourth blocks need to be.

Also, while leveraged instruments are not usually held for more than a day, shrewd investors can weigh risks of being invested for more than a day and amend the “second block” to rebalance on a 2-day basis, a 5-day basis or more.

The “third block” represents a prickly challenge: being invested in larger amounts often yields more profit. With larger amounts, allocations among instruments to reach “whole numbers” relative to the price of the instruments improve. This can often lead to better performance.

For instance, we’ll try and replicate the MicroSectors “+3X Long FANG+ ETN” (ticker FNGU) which adds four companies to FATANG – Alibaba (BABA), Baidu (BIDU), NVIDIA (NVDA) and Twitter (TWTR) – weighs them equally and rebalances daily. This Exchange-Traded Note (ETN) is estimated to have close to $1.9 billion in assets under management (AUM).

Given that FNGU is not available for European retail investors, this instrument can be effectively be replicated by using the 3X ETPs on Facebook (FB3), Apple (AAP3), Amazon (AMZ3), Netflix (NFL3), Alphabet (GOO3), Alibaba (BAB3), Baidu (BID3), NVIDIA (NVD3), Tesla (TSL3) and Twitter (TWT3) for a slightly lower expense ratio. Note: Other costs, like the spread and brokerage commissions, have not been included.

Consider the month of January 2021 where these stocks continued to ride the highs from their closing days in 2020. It is a reasonable assumption to make that this basket would carry forward with solid gains. However, “third block” amounts yield different results for this basket.

Readers should note that “equally-weighted” in this case means the nearly same amounts are invested into purchasing each instrument and not the same number of instruments.

Let’s consider the $20,000 case and examine the initial (starting) portfolio held. FB3 and NFL3 are very close to each other in price and the same is true for BAB3 and TSL3. However, when the investment is being spread across a large number of instruments, the difference in number of ETPs purchased (Note: fractional investments are not being considered) is 13.3% and 4.8% respectively.

Also, since all instruments do not move in tandem with the same magnitude, performance contribution is not going to be the same. When scaling up to larger amounts, the relative price neighbour difference changes. This causes the variance in performance when scaling up or down the investment value.

At the $20,000,000 level, the basket closes the month ahead of FNGU’s gains by a paltry 1.2% which reduces to 0.8% if held till the first week of August.

This is an important lesson for investors in two ways:

  1. When it comes to the top-tier baskets comprised of very high-priced instruments, it might pay to “go big”.

  2. Considering the fact that instruments like FNGU show very high variability in performance versus the benchmarks, “going your own way” in replicating popular instruments often makes sense for strategic players such as institutional investors but is not necessarily the best option for retail investors.

Another important factor to consider is that an investor should consider the gains: being invested in FNGU or the $20 million basket yields around 32% versus 18% in benchmarks. Meanwhile, a number of opportunities crystallized using themes yielded much higher gains in a shorter period.

This highlights the value of making a tactical play. While it would certainly make sense to be invested in a large index fund or special ETN such as FNGU as part of an investor’s “core portfolio”, having funds ready to make tactical plays with Leverage Shares instruments in a “satellite portfolio” is a very strong value-building move. Using leveraged instruments such as the 3X ETPs also allows new tactical buyers to get magnified exposure and performance while they weigh the benefits of building “core” and “satellite” portfolios”.

Investors should review Leverage Shares’ full list of short & leveraged ETPs as well as trackers to build out their portfolios in a variety of sectors and themes. Also, investors should subscribe to the mailing list to stay abreast of new developments.

Your capital is at risk if you invest. You could lose all your investment. Please see the full risk warning here.

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