Replies to post #37420 on A.I.M. Users Bulletin Board (AIMUSERS)

[ls7550]

Suppose for example someone had bought a 3X leveraged inverse etf for the S&P 500...SPXS...on January 2nd of this year for a cash substitute.

This etf had a 5:1 reverse stock split at the end of August. So, its adjusted close at the first of the year was $78.20. Yesterday it closed at $36.77. This is a decline of $41.43 per share, or -52.9%. However, it will need an increase of +112.67% just to get back to breakeven.

Hi Ray

SPXS 33.3% (3x S&P short), TIP 66.7% start date Jan 2nd 2013, compared to SH (1x S&P short) as of the end of November had the 33.3 SPXS/66.7 TIP combination at 0.781184842 compared to 0.783963691 for SH (total gains (losses)). Just a bit of noise in the difference.

i.e. on a level basis, the third in 3x short (two thirds in TIPS) compared to 100% 1x short.

[Toofuzzy]

>>>>>>>Getting back to SLW. Looking at a chart of SLW and how far it has declined there is no way I would now hedge it with an inverse fund. The time to do that was about a year ago when SLW was around $40 a share....now it is around $19.40. At the time SLW was selling for around $40 a share DSLV was then selling for approximately $20 a share. DSLV has since tripled in value and currently selling for almost $60 a share, while SLW has lost about 50% of its value. If it were me I would wait until SLW has some extended gains before I would consider hedging it with DSLV.<<<<<<<

That is my point and why I was looking at this. I just bought a few more shares of SLW.

I wouldnt have a complaint about my "cash" tripling in value.

Toofuzzy

[BowlerBob]

Ray,

I have been waiting for someone to "chime in" in response to your post, but no has, as yet, so I will attempt to do so. I see two conflicts with your statements that I wish to address: 1)

The problem is the daily "compounding" problem. If a fund drops 10% in value then it requires an 11% increase in value just to get back to breakeven. A 25% value decline requires a 33% increase to get back to breakeven...etc.

This statement is misleading, not because the math is untrue, but because the math is true of anything you discuss in terms of percentages. It is true of Inverse ETFs; Leveraged ETFs; regular,basic ETFs; all stocks; mutual funds; etc...anything you express in percentages. So, to apply it to Inverse or Leveraged ETFs, as though it was a problem unique to them, is misleading.

2)

With that in mind using any sort of inverse fund as a cash substitute for any lengthy period of time really creates a problem that is hard to correct. Suppose for example someone had bought a 3X leveraged inverse etf for the S&P 500...SPXS...on January 2nd this year for a cash substitute. ... So,IMO,inverse funds...leveraged or not...are terrible holdings as a long-term cash substitute.

Then two paragraphs later you give an example that directly contradicts this opinion.

Getting back to SLW. Looking at a chart of SLW and how far it has declined there is no way I would now hedge it with an inverse fund. The time to do that was about a year ago when SLW was around $40 a share...now it is around $19.40. At the time SLW was selling for $40 a share DSLV was then selling for approximately $20 a share. DSLV has since tripled in value and currently selling for almost $60 a share, while SLW has lost 50% of its value.

So, which is it? You shouldn't hold these ETFs for more than a short-term period, or DSLV gained 200% in a year, while its underlying ETF (SLW)lost 50%? Let's see, a non-leveraged Inverse ETF should have gained about 50% while SLW lost that amount, a 2X Leveraged Inverse ETF should have gained about 100%, and a 3X leveraged Inverse ETF should have gained about 150% -- BUT it, instead, gained nearly 200%. That is not a bug, it's a feature.

As far as the timing is concerned, that is what AIM is helping you with -- Buy low and Sell high. When your basic investment in SLW is rising enough to cause AIM to give Sell advice, the price of the inverse ETF is falling. So the cash AIM is generating is buying more of the decreasing inverse fund. And when the market finally turns around and SLW begins to fall, the inverse fund is then rising in price and is worth more than you paid. So you are buying low and selling high with both your basic investment vehicle AND your cash. I would suggest though, that Clive's advice about putting only 1/3 of your cash in the 3X ETF is a wonderfully wise bit of caution, and is better than putting all your cash in a non-leveraged Inverse ETF.

I am going to send a second post to cover the part of your discussion that I agree with.

Regards,

Bob

[BowlerBob]

Ray,

In this post, I want to discuss the pricing of Index ETFs.

Index ETFs, like IWM (Russell 2000) or SPY (S&P 500) are priced as a fraction of the underlying Index (in these two instances, 1/10 of the Index value). Their prices have nothing at all to do with the normal Supply/Demand price structure -- that is taken care of in the value placed on the Index, along with the appropriate "weighting". The SEC requires the Index provider to generate its value every 15 seconds during the trading day, and these basic ETFs must readjust their price to conform. This means that the volume of trading for IWM or SPY has absolutely no bearing on its price. The price is adjusted 1560 times during the normal trading day -- any slippage is taken care of then.

However, the basic price structure of the Inverse and Leveraged ETF versions is quite different. The issuer arbitrarily decides on the price so that it (the price) can move up or down as needed to reflect the purpose of that ETF. That is why they will often have Splits or Reverse Splits to put the issue back into a medium price range. The pricing of these ETFs is not based on the PRICE of the Index, but the movement in price. And this is where your statements about % gains or losses is appropriate -- it gives the correct impression. These instruments connect their price movements to the % change in price of the underlying Index -- not the actual dollars and cents of a price rise or drop.

Not withstanding my remarks in the other post, I also tend to agree with your caution about using Inverse ETFs, Leveraged or Non-Leveraged, as a cash pool, especially when beginning a new AIM position. We don't know where the market is going to go from here on, and neither does AIM. We can look at a graph of the past action and see that it has been in an Up Trend or a Down Trend, until now, but we don't know what tomorrow will bring. Also AIM cannot determine that either until some time has passed. So, my thinking would be to just use ordinary Cash instruments until AIM proves to you, by generating sales, that the trend is Up, and then put the sales cash into the Inverse ETF. That way you can "work into" the position and not be "overexposed".

Regards,

Bob