Inverse ETFs Research Articles

Arbitrage Opportunities and Overnight Returns in Leveraged and Inverse ETFs

Arbitrage Opportunities and Overnight Returns in Leveraged and Inverse ETFs

Unleveraged Portfolios and Pure Allocation Return

In asset management, the portfolio leverage affects performance, and can be subject to constraints and operational limitations. Due to the possible leverage aversion of the investors, the comparison between portfolio performances can be incomplete or misleading. We propose a procedure to unleverage the mean-variance efficient portfolios to satisfy a leverage requirement. We obtain a class of unleveraged portfolios that are homogeneous in terms of leverage, so therefore properly comparable. The proposed unleverage procedure permits isolating the pure allocation return, i.e., the return component, due to the qualitative choice of portfolio allocation, from the return component due to the portfolio leverage. Theoretical analysis and empirical evidence on actual data show that efficient mean-variance portfolios, once unleveraged, uncover mean-variance dominance relations hidden by the leverage contribution to portfolio return. Our approach may be useful to practitioners proposing to take long positions on “short assets” (e.g. inverse ETF), thereby considering short positions as active investment choices, in contrast with the usual interpretation where are used to overweight long positions.

The Impact of Leveraged and Inverse ETFs on Stock Index Futures Market in Korea

The Impact of Leveraged and Inverse ETFs on Stock Index Futures Market in Korea

Leveraged ETFs: Are You Prepared for the Volatility Jumps? Global Perspectives on the Short-Term versus Longer-Term Risk Profiles

Leveraged and inverse ETFs represent one of fast growing areas in the ETF industry, with the global AUM breaking $60 billion. The regulatory bodies in many countries are approving the listing of these products. The recent financial market turmoil in February 2018 has exposed the risk behavior of these ETFs in the time of market stress, which are often misunderstood by investors and can catch them by surprise. In this study, we analyze leveraged ETFs risk profiles in both short-term and long-term periods. As leveraged ETFs and inverse ETFs are often used for short-term trading purposes, understanding the nature of short-term volatility is highly critical. We also survey the landscape of the major markets with listed leveraged ETFs outside the U.S., including Asia Pacific and Canada. We examined the volatility behavior of leveraged products in these markets and came to the same conclusion. The near-term volatility jumps more than what the leverage ratio suggested. We’ve also noticed the degree of jumps vary from market to market. Globally, leveraged and inverse ETFs are growing at a healthy pace, led by a faster growth in Asia in 2016. After Japan, South Korea, and Taiwan, Hong Kong became the latest market, allowing both inverse and leveraged products on Hong Kong and China stock indexes. It is in the great interest of global investors to fully understand the nature of these instruments to use them effectively in portfolio management.

Consistent Pricing of Options on ETFs and Options on Inverse ETFs

Consistent Pricing of Options on ETFs and Options on Inverse ETFs

Empirical study on Hedge Effectiveness of Inverse ETF

Empirical study on Hedge Effectiveness of Inverse ETF

An Empirical Study on Price and Return of Commodity ETFs in Korea

This study analyses empirically the Granger causality between commodity ETFs listed in KRX (Korea Stock Exchange) and the price determinants of the underlying commodities as well as the KOSPI200 index and the underlying indices, and compares the performance of four commodity ETFs : gold futures, oil futures, soybean futures and the copper price. The main findings are as follows : First, the commodity ETFs tracking gold futures, oil futures and soybean futures prices in the sample from the inception to June 2015 were not directly related to the price determinants of the underlying commodities except for the copper ETF which was affected by the oil price as one of the price determinants of copper. In addition, all four ETFs were not related to the KOSPI200 index while they were affected by the underlying indices. Second, the soybean futures ETF outperformed the KOSPI200 index in terms of the cumulative returns and the oil futures ETF recorded the worst performance in terms of the cumulative returns and IR (information ratio). Third, the average tracking error of each ETF except for the oil futures ETF showed a positive value and the price of each ETF except for the soybean futures ETF has been undervalued compared to its net asset value. From the above findings, we can infer that investors in the copper ETF should closely watch the movement of the oil price to enhance the return and investors in the commodity ETFs should first consider agriculture-related ETFs rather than oil-related ETFs considering the price volatility. In addition, the inverse ETFs for copper and agriculture-related products should be introduced following the oil and gold futures inverse ETFs to protect against negative returns in a declining period of commodity prices.

Leveraged Funds: Robust Replication and Performance Evaluation

Leveraged and inverse ETFs seek a daily return equal to a multiple of an index' return, an objective that requires continuous portfolio rebalancing. The resulting trading costs create a tradeoff between tracking error, which controls the short-term correlation with the index, and excess return (or tracking difference) - the long-term deviation from the leveraged index' performance. With proportional trading costs, the optimal replication policy is robust to the index' dynamics. A summary of a fund's performance is the implied spread, equal to the product of tracking error and excess return, rescaled for leverage and average volatility. The implied spread is insensitive to the benchmark's risk premium and offers a tool to compare the performance of funds tracking the same index with different factors and tracking errors.

Investment Analysis of Leveraged ETFs

Due to the lower management costs and higher liquidity versus traditional mutual funds, the ETFs category has recently expanded at a faster pace than anytime before. The transparency in publicly traded ETFs gives investors access to diversified portfolios that were only available to large institutions before. In this paper, we study the ETFs’ features, benefits and disadvantages from the asset management perspective with an emphasis on the structure and risk analysis of the leveraged ETFs. Our research indicates that ETFs, though attractive in many aspects, should be managed with caution. The leveraged and inverse ETFs can result in huge negative returns due to value decay effects and high bid-ask trading spreads.

Predictable ETF Order Flows and Market Quality

Institutional order flow can often be predicted. Examples include trades by index funds when stocks are added to or deleted from indexes; the rebalancing trades of rules-based ETFs, including leveraged and inverse ETFs; rebalancing to maintain target asset weights; rebalancing to maintain option hedges; and roll outs of expiring futures contracts. Some authors have highlighted the destabilizing effects on market quality related to predictable order flow. The goal of this article is to provide a deeper analysis of the existing infrastructure and the issues that arise from the execution of predictable institutional orders. Considering the roles of information and competition, predictable orders should in long run equilibrium have minimal effects on prices, because they are most often not motivated by fundamental information, they attract natural counterparties, and they benefit from additional liquidity supply.

Leveraged/Inverse ETFs and Volatility in the Korean Market

There have been the concerns that leveraged and inverse ETFs contribute to the financial crisis of 2007~2008. Several researchers have investigated this important issue. However, there is no consensus yet whether leveraged and inverse ETFs destabilize a financial market. Financial stability is an important subject for policy makers, practitioners and academia. ETFs are one of the most important financial innovations. In particular, leveraged and inverse become more and more influential. Therefore, such lack of academic and practical consensus is a significant challenge. In this paper, we analyze whether leveraged and inverse ETFs affect the price and volatility of Korean market. Thus, our research contributes to the body of literature and to the design of public policies and trading strategies. Our research can also advance the development of ETF industry, one of the fastest growing and promising sector in the Korean financial market.

The Impact of Leveraged and Inverse ETFs on Underlying Real Estate Returns

Leveraged and inverse ETFs (LETFs) were introduced in 2006. By 2008 there was concern that the requirement of LETFs to rebalance near the close might have a significant impact on the prices of the stocks in the underlying indexes. We examine the impact of trading activity induced by six real estate‐related LETFs on the late‐day price dynamics of 63 real estate sector stocks. Through a comparison of sample and control stocks and through a regression model of LETF rebalancing, we find that these LETFs significantly impact the prices of component stocks, increase their volatility and contribute to price momentum.

Crooked Volatility Smiles: Evidence from Leveraged and Inverse ETF Options

We find that the leverage factors of leveraged and inverse exchange traded funds can effect the crookedness' of volatility smiles. We model leveraged and inverse ETF option prices using partial differential equations (PDEs) and determine closed-form solutions for the option values following the method of Lipton (2001). We study a sextet of leveraged and inverse ETFs based on the S&P 500. We show that the Heston model can reproduce the crooked smiles observed in the the market price of options on leveraged and inverse leveraged exchange traded funds. By analyzing the asymptotic behavior for the implied variances at extreme strikes, we observe an approximate symmetry between pairs of LETF smiles empirically consistent with the predictions of the Heston model.

Predictable ETF Order Flow and Market Quality

Research on certain types of institutional order flow has highlighted potential destabilizing effects on market quality related to the fact that these orders can be anticipated by other market participants. Examples include the rebalancing of rules-based indexes and ETFs, including end-of-day rebalancing of leveraged and inverse ETFs, rebalancing to maintain target asset weights and option hedges, and rolls out of expiring futures contracts. The goal of this paper is to provide a deeper analysis of the infrastructure that exists and the issues that arise from the execution of predictable institutional orders, with emphasis on order flows related to ETF activity. Considering the roles of information and competition, predictable orders should typically have minimal effects on prices because they are not motivated by fundamental information, they attract natural counterparties, and they benefit from additional liquidity supply. Empirical research on the price effects of ETF trading or other forms of predictable order flow should be guided by relevant economic theory and a full appreciation of the infrastructure that exists to facilitate such execution. Estimates of the price effects of ETF trading or other forms of predictable order flow are unlikely to be accurate unless the researcher can also measure other order flow that is correlated with the predictable order flow being studied.

Bad news bears

Purpose – This study aims to look into how volatility significantly impacts the tracking error for daily-rebalanced leveraged bull and bear ETFs. Design/methodology/approach – Using Morningstar return data and Chicago Board Options Exchange (CBOE) volatility index (VIX) data, the paper examines the daily tracking error for leveraged bull and bear ETFs. Tracking error is defined as the difference between the daily returns for a leveraged bull or bear ETF and the multiple of the daily return for that ETF's respective underlying benchmark index. Findings – Changes in the market VIX of the CBOE have a significant and opposite effect on the daily returns for both leveraged bull and bear ETFs. Furthermore, these effects are more pronounced for bear ETFs than similarly leveraged bull ETFs. Research limitations/implications – The sample period (June 19, 2006 to September 22, 2009) contains periods of extraordinarily high volatility. Considering that the VIX reached an all-time high during this period, the results may be time-period specific and may not translate to other time periods. Practical implications – The implication is that market timing may be feasible for enhancing daily returns for both leveraged bull and bear ETFs. However, any specific timing strategies go beyond the scope of this paper. Originality/value – In this study, the paper examined the effects of expected market volatility on the daily tracking error of leveraged bull and bear ETFs. Specifically, the paper performed multiple linear regression analysis using Morningstar return data for the ETFs and their underlying benchmark and CBOE VIX data. The findings suggest that market timing could be beneficial for increasing daily yields for leveraged and inverse ETFs.

Are Leveraged and Inverse ETFs the New Portfolio Insurers?

This paper studies Leveraged and Inverse Exchange Traded Funds (LETFs) from a financial stability perspective. Mechanical positive-feedback rebalancing of LETFs resembles the portfolio insurance strategies, which contributed to the stock market crash of October 19, 1987 (Brady Report, 1988). I show that a 1% increase in broad stock-market indexes induces LETFs to originate rebalancing flows equivalent to $1.04 billion worth of stock. Price-insensitive and concentrated trading of LETFs results in price reaction and extra volatility in underlying stocks. Implied price impact calculations and empirical results suggest that they contributed to the stock market volatility in the 2008-2009 financial crisis and in the second half of 2011 when the European sovereign debt crisis came to the forefront. Although LETFs are not as large as portfolio insurers of the 1980s and have not been proven to disrupt stock market activity, their large and concentrated trading could be destabilizing during periods of high volatility.

Leveraged and inverse ETF performance during the financial crisis

PurposeLeveraged and inverse ETFs (hereafter leveraged ETFs) have received much press coverage of late due to issues with their performance. Managers and the media have focused investors' attention on the impact of compounding, when the funds are held for more than one day. The aim of this paper is to lay out a framework for assessing the performance of leveraged ETFs.Design/methodology/approachThe authors propose a simple way to disentangle the effect of compounding and that of the management of the fund and the trading premiums/discounts, all of which affect investors' bottom line. The former is influenced by the effectiveness and the costs of the manager's (synthetic) replication strategy and the use of leverage. The latter reflects liquidity and the efficiency of the market.FindingsThe paper finds that tracking errors were not caused by the effects of compounding alone. Depending on the fund, the impact of management factors can outweigh the impact of compounding, and substantial premiums/discounts caused by reduced liquidity during the financial crisis further distorted performance.Originality/valueThe authors propose a framework for practitioners to evaluate the performance of leveraged ETFs. This framework highlights a very topical issue, that of the impact of synthetic replication, which all leveraged ETFs use. Financial regulators such as the SEC and the Financial Stability Board have all taken issue with synthetically replicated ETFs. In leveraged ETFs, this issue is masked by the effects of compounding. The framework the authors propose allows investors to disentangle the two effects.

Are Leveraged and Inverse ETFs the New Portfolio Insurers?

This paper studies Leveraged and Inverse Exchange Traded Funds (LETFs) from a financial stability perspective. Mechanical positive-feedback rebalancing of LETFs resembles the portfolio insurance strategies, which contributed to the stock market crash of October 19, 1987 (Brady Report, 1988). I show that a 1% increase in broad stock-market indexes induces LETFs to originate rebalancing flows equivalent to $1.04 billion worth of stock. Price-insensitive and concentrated trading of LETFs results in price reaction and extra volatility in underlying stocks. Implied price impact calculations and empirical results suggest that they contributed to the stock market volatility in the 2008-2009 financial crisis and in the second half of 2011 when the European sovereign debt crisis came to the forefront. Although LETFs are not as large as portfolio insurers of the 1980s and have not been proven to disrupt stock market activity, their large and concentrated trading could be destabilizing during periods of high volatility.

Hedging with Swaps Under a Parallel Shift of the Yield Curve

Hedging a bond position under a parallel shift of the interest rate has been largely considered and analyzed, though the underlying assumption is less realistic. Indeed both practical and theoretical reasons support the consideration to grant attention to this particular situation. Interest rate swaps (IRS) appear to be instruments largely used by market participants (companies,local governments, financial institutions, traders ...) for many purposes including debt structuring, regulatory requirements and risk management.However there are no clearly similar analyzes as those performed for bonds in the case of IRS and under the above mentioned assumption. Therefore our main target in this paper is to perform a systematic analysis of a portfolio hedging by means of a portfolio including swaps. Particularly, we are able to clarify the suitable swap sensitivities to make use in hedging and risk management, completing the well known bond duration and convexity in the setting of swaps.Our present results can provide a support for practitioners, using a portfolio of swaps and/or bonds, in their hedge decision-making. They may be also helpful to discern the various broker advertisements about switching to alternative instruments (as VIX futures, inverse ETF, Swap future ...) for the hedging purpose instead of just using a classical bond portfolio.

A Survey on Leveraged and Inverse Exchange-Traded Funds

Leveraged and inverse ETFs, which promise to deliver two or three times the return of a specified benchmark (in a positive or a negative fashion) on a daily basis, have become a fast-growing innovation in the ETF industry. In this article, a sample of 40 inverse and 28 leveraged ETFs belonging to Proshares family is examined to see how frequently these ETF types deliver their stated multiple, finding that they basically fail to meet their daily target. We then search whether there is any significant day-of-the-week effect on the effort of Proshares to achieve their investment goal. The results indicate that the discrepancy between the actual return and the predefined multiple is smaller on Wednesday. In the last step, we compare Proshares to regular ETFs tracking the same indexes, at first taking into account the daily volume, trading frequency, and expense ratios. The results demonstrate that the leveraged ETF market is less liquid than the regular ETF market (less volume and trading frequency) while the leveraged and inverse ETFs are more expensive than their regular counterparts. Secondly, we compare return and risk of Proshares and regular ETFs, taking into consideration the return and risk of the indexes as well. The findings show that, on average, the inverse ETFs underperform their regular ETF competitors and the corresponding indexes while they are more risky than them. On the other hand, the results of the study provide weak evidence that the leveraged ETFs, on average, outperform the regular ETFs and the indexes but they are more hazardous.