Our Short & Leveraged Single-Stock ETPs could be challenging for some investors looking for new innovative products to add to their portfolio. In this six-part educational series, we describe the idea behind our products, their construction, features and their benefits to investors as well as when compared to other similar-seeming products.
Leverage Shares’ single-stock ETPs track indices by iSTOXX and NYSE in order to define their value in a transparent manner. Single-stock indices – especially those that are leveraged and inverse – produce daily returns. The daily returns aspect, in turn, influences the daily rebalancing feature of our products.
Rebalancing: The Why and How
Both leveraged and inverse indices use the end-of-day price of the underlying stock to define the closing level of the index. The fund represented by the ETP, in return, attempts to mimic this level to define the number of shares to buy or shares to sell short as closely as possible.
For instance, consider two hypothetical funds: a 2x long ETP and a -1x short ETP with the same underlying stock, in two scenarios:
For the 2x long ETP, here’s how the events of the day would impact the levels and exposure of the ETP at the end of the day (EOD) and the corrective actions required:
Similarly, for the -1x short ETP, here’s how the events of the day would impact the exposure of the ETP and the corrective actions required:
Note: The exposure is denoted as negative because these are short positions held by the fund. Therefore, in the case of the underlying going up by 5%, the portfolio manager will be reducing the short exposure by $10 (which, because it’s a short position, is represented as a positive value).
Thus, the daily rebalancing of the ETP is a necessary function to consistently offer the leverage and inverse positions promised to the holder of these products. However, this also brings into effect a “daily compounding” effect that can confound some investors. Let’s dig in to clarify some misconceptions.
Daily Compounding: Often Counter-Intuitive
Let’s consider two cases to highlight how daily compounding is a factor to be reckoned with:
Scenario 1: Upward Trending Market
It can be seen that the daily compounding formula adds nearly 33% in gains over a 10-day period when compared to the expectations of a 2x investment without any adjustment for the factor restoration.
Similarly, in the case of the -1x short ETP:
It can be seen that the daily compounding formula prevents a loss of nearly 23% over a 10-day period when compared to the expectations of a -1x investment without any adjustment for the factor restoration.
Scenario 2: Choppy Market
Consider a scenario where a rise of 5% in a single day is followed by a drop of 5% in the next. These kinds of “oscillations around the mean” would impact the 2x ETP’s performance as thus:
It can be seen that an expected shortfall of 2% was magnified to more than twice that amount because of the daily compounding formula.
In the case of the -1x ETP:
It can be seen that the loss in the underlying is identical to the loss in the ETP. Meanwhile, not performing the factor restoration would have provided a gain of 1%.
Scenario 3: Oscillations Around a Trending Mean
It is possible, in some instances, that the performance of the product with daily rebalancing is nearly identical to when there is none. For instance, consider the 2x long ETP in a scenario where the underlying falls by 1.9% in a day followed by a rise of nearly 4% in the next. The 10-day performance would be:
It can be seen that the gains from the ETP mirror that of a leveraged investment without any daily rebalancing.
Now, consider the -1x short ETP in a scenario where the underlying falls by 4.96% in a day followed by a rise of 2.48% in the next. If this happened consistently over 10 days, the 10-day performance would be:
In this case, it can be seen that the ETP’s performance mirrors that of simply shorting a stock.
Note: Readers should keep in mind the scenarios modelled didn’t take into account any fees or commissions.In Conclusion
The central takeaway from this demonstration is that investing in S&L ETPs, as opposed to other means of trading with leverage or going short, has both its pros and cons. Investing in our products come with a fair bit of market risk – since these are concentrated investments in individual stocks. Needless to say, a savvy investor performing the right level of due diligence with active portfolio management practices and a keen perception of market sentiment has the potential to capitalise on market trends.
Sandeep joined Leverage Shares in September 2020. He leads research on existing and new product lines, asset classes, and strategies, with special emphasis on analysis of recent events and developments.
Sandeep has longstanding experience with financial markets. Starting with a Chicago-based hedge fund as a financial engineer, his career has spanned a variety of domains and organizations over a course of 8 years – from Barclays Capital’s Prime Services Division to (most recently) Nasdaq’s Index Research Team.
Sandeep holds an M.S. in Finance as well as an MBA from Illinois Institute of Technology Chicago.
Violeta joined Leverage Shares in September 2022. She is responsible for conducting technical analysis, macro and equity research, providing valuable insights to help shape investment strategies for clients.
Prior to joining LS, Violeta worked at several high-profile investment firms in Australia, such as Tollhurst and Morgans Financial where she spent the past 12 years of her career.
Violeta is a certified market technician from the Australian Technical Analysts Association and holds a Post Graduate Diploma of Applied Finance and Investment from Kaplan Professional (FINSIA), Australia, where she was a lecturer for a number of years.
Julian joined Leverage Shares in 2018 as part of the company’s primary expansion in Eastern Europe. He is responsible for web content and raising brand awareness.
Julian has been academically involved with economics, psychology, sociology, European politics & linguistics. He has experience in business development and marketing through business ventures of his own.
For Julian, Leverage Shares is an innovator in the field of finance & fintech, and he always looks forward with excitement to share the next big news with investors in the UK & Europe.
Oktay joined Leverage Shares in late 2019. He is responsible for driving business growth by maintaining key relationships and developing sales activity across English-speaking markets.
He joined Leverage Shares from UniCredit, where he was a corporate relationship manager for multinationals. His previous experience is in corporate finance and fund administration at firms like IBM Bulgaria and DeGiro / FundShare.
Oktay holds a BA in Finance & Accounting and a post-graduate certificate in Entrepreneurship from Babson College. He is also a CFA charterholder.
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