Leveraged Exchange-Traded Funds: A Comprehensive Guide to Structure, Pricing, and Performance

174 Pages·2016·1.672 MB·English

by  Narat Charupat, Peter Miu (auth.)

LEVERAGED
EXCHANGE-TRADED
FUNDS
A Comprehensive Guide to Structure,
Pricing, and Performance
NARAT CHARUPAT & PETER MIU
Leveraged Exchange-Traded Funds

Leveraged Exchange-
Traded Funds
A Comprehensive Guide to Structure,
Pricing, and Performance
Narat Charupat and P eter Miu
LEVERAGEDEXCHANGE-TRADEDFUNDS
Copyright © Narat Charupat and Peter Miu 2016
Softcover reprint of the hardcover 1st edition 2016 978-1-137-47820-7
All rights reserved. No reproduction, copy or transmission of this
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Any person who does any unauthorized act in relation to this publication
may be liable to criminal prosecution and civil claims for damages.
First published 2016 by
PALGRAVE MACMILLAN
The authors have asserted their rights to be identified as the authors of this
work in accordance with the Copyright, Designs and Patents Act 1988.
Palgrave Macmillan in the UK is an imprint of Macmillan Publishers
Limited, registered in England, company number 785998, of Houndmills,
Basingstoke, Hampshire, RG21 6XS.
Palgrave Macmillan in the US is a division of Nature America, Inc., One
New York Plaza, Suite 4500, New York, NY 10004-1562.
Palgrave Macmillan is the global academic imprint of the above companies
and has companies and representatives throughout the world.
Hardback ISBN: 978–1–349–56501–6
E-PDF ISBN: 978–1–137–47821–4
DOI: 10.1057/9781137478214
Distribution in the UK, Europe and the rest of the world is by Palgrave
Macmillan®, a division of Macmillan Publishers Limited, registered in
England, company number 785998, of Houndmills, Basingstoke,
Hampshire RG21 6XS.
Library of Congress Cataloging-in-Publication Data
Charupat, Narat, author.
Leveraged exchange-traded funds : a comprehensive guide to
structure, pricing, and performance / Narat Charupat, Peter Miu.
pages cm
Includes bibliographical references and index.
1. Exchange traded funds. I. Miu, Peter, author. II. Title.
HG6043.C43 2015
332.63(cid:2)27—dc23 2015026190
A catalogue record for the book is available from the British Library.
Printed in the United States of America.
Contents
List of Figures vii
List of Tables ix
1 Introduction 1
2 Regulations and Taxations 13
3 Mechanics 21
4 Return Dynamics and Compounding Effects 35
5 Pricing Efficiencyy 49
6 Performance and Tracking Errors 73
7 Trading Strategies 111
8 Options on LETFs 139
Notes 165
Bibliographyy 171
Index 175
v

Figures
4.1a Payoffs of a One-Year $100 Investment in a 2x ETF
under Low Volatilityy 44
4.1b P ayoffs of a One-Year $100 Investment in
a −2 x ETF under Low Volatilityy 45
4.2a Payoffs of a One-Year $100 Investment in a 2x ETF
under High Volatilityy 47
4.2b Payoffs of a One-Year $100 Investment in a − 2x ETF
under High Volatilityy 47
7.1 Expected Return under Low-Volatility Bullish Market
Conditions 116
7.2 Expected Return under High-Volatility Bullish Market
Conditions 116
7.3 Expected Return under Low-Volatility Bearish Market
Conditions 117
7.4 Expected Return under High-Volatility Bearish Market
Conditions 117
7.5 A Plot of Expected Two-Year Holding Period Returns
against the Corresponding Standard Deviations of
Returns for Different LETFs with Hypothetical
Leverage Ratios of +1x, +1.5x, +2x, +2.5x, and
+3x, Respectivelyy 119
7.6 Cumulative Investment Value of Long-Only
versusShort-OnlyyStrategyy 124
8.1 A Plot of Implied Volatility against Natural
Logarithm of Moneyness Ratio for Call Options
on SPY and SSO 154
8.2 A Plot of Implied Volatility against Natural
Logarithm of Moneyness Ratio for Call Options
on SPY and SDS 155
8.3 A Plot of Implied Volatility against Transformed
Moneyness Measure for Call Options on SPY
and SSO 159
8.4 A Plot of Implied Volatility against Transformed
Moneyness Measure for Call Options on SPY
and SDS 159
vii

Tables
1.1 Total Number, Assets under Management, and
Average Daily Volume of LETFs in United States in
2012 by Underlying Asset Classes 6
1.2 Top Ten LETFs in United States in 2012 by Their
Assets under Management 7
1.3 Top Ten LETFs Based on the Annual Contract Volume
of Their Options Trading on the Chicago Board of
Exchange in 2013 10
3.1 Trading Statistics of Selected LETFs 31
4.1 LETF’s Two-Day Compounded Returns under Different
Scenarios 40
4.2 Simulation Results 46
5.1 Descriptive Statistics 54
5.2 Price Deviations 56
5.3 Correlations among Price Deviations 59
5.4 Price Deviations Based on the Returns on Their
Underlying Indices 61
5.5 Relative Size of LETFs and Inversed ETFs 67
5.6 Regression Estimates 69
6.1 Descriptive Statistics 99
6.2 H alf-Year Performance (in Percentage Points) of Funds
Relative to Underlying Benchmarks 102
6.3 Single-Variable Regression Results 105
6.4 Three-Variable Regression Results 108
7.1 Optimal Leverage Ratio under Different Market
Conditions 116
7.2 Expected Returns and Standard Deviations of
Returns for Different LETFs 119
7.3 Long-OnlyyversusShort-OnlyyStrategyy 122
7.4 Proportion of Time in Which Shorting the −3x
LETF Gives Us a Higher One-Year Compounded
Return Than Going Long on the +3x LETF 132
7.5 Sharpe Ratio from Shorting the −3x LETF 134
7.6 Simulated Median One-Year Compounded Return
on Pair Strategyy 136
ix