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.
