Inverse Exchange-traded Funds Research Articles

Leveraged funds: robust replication and performance evaluation

Leveraged and inverse exchange-traded funds seek daily returns equal to fixed multiples of indexes' returns, but the ensuing rebalancing costs create a tension between a high correlation with the index and a low average deviation from the leveraged index' performance. With proportional trading costs, we find that the optimal replication policy is robust to the index' dynamics and obtain a sufficient statistic for index replication performance, the implied spread, which is insensitive to risk-premia and enables comparisons of funds tracking different factors of an index. Overall, the impact of trading costs on replication performance is comparable to or higher than the effect of management fees.

Levered and Inverse Exchange-Traded Products: Evidence from Simulations

Levered exchange-traded products have been criticized as offering inferior long-term returns for two reasons: their higher volatility and, apparently, the belief that volatility diminishes long-term expected returns. Following the approach of Pessina and Whaley (2021) we analyze simulated returns of levered and inverse exchange traded funds (ETFs) and conclude that their expected long-run values are not diminished by volatility. We identity natural counterparties to the rebalancing trades of levered exchange traded funds (LETFs) and analyze the impact of autocorrelation on daily-rebalanced LETF returns, theoretically and empirically, for both LETFs and their counterparties. The results indicate that negative (positive) autocorrelation in daily returns will cause LETFs to perform relatively poorly (well) and their counterparties to perform relatively well (poorly). Accordingly, the extent to which levered and inverse ETFs have legitimate hedging applications and reasonable risk-adjusted returns (setting aside trading costs and fund expenses) depends on the extent to which the underlying returns are consistent with weak-form market efficiency.

Short-selling and its applications on the Saudi Arabia Stock Exchange Fiqhi Authentication study

Research Subject: short-selling and its applications on the Saudi Arabia Stock Exchange. Fiqhi Authentication study Research Objectives: - Clarifying the short-selling and its applications on the Saudi Arabia Stock Exchange. - Alternatives to Short-selling Research Methodology: Analytical Descriptive. The most important findings. There is a distinction between naked short-selling – the selling of stocks that the person “does not own” or without first obtaining approval for borrowing them – and the regular short-selling where an investor sells stocks borrowed from its owner and return them back later after a certain time – covered shorting. Regular short-selling is a combined contract of sale and loan transactions, where the loan is set against a certain dividends to the borrower to be paid to the broker. There is a number of alternatives to short-selling such as: put options and inverse exchange-traded funds.

How do Inverse Exchange-Traded Funds Targeting Taiwan Shares Track their Underlying Indices?

Amid the tremendous interest of Taiwanese investors in short selling, seven inverse exchange-traded funds (IETFs) targeting the inverse of Taiwan equity benchmark indices were rolled out one after another on the Taiwan market in less than four years. This paper evaluated the tracking performance of these IETFs against their stated return objectives and investigated what factor, fund management issue or market inefficiency, correlated more to performance. The empirical results showed that fund management issues accounted for the majority of the IETFs’ variation in tracking performance, whereas the impact of market inefficiency was relatively small and stable. The study further examined the fundamental determinants of IETFs’ return deviation and discovered that target return volatility, management fee rates, the availability of corresponding futures, share turnover, and turnover rate were influential factors. Among those factors, target return volatility and management fee rates were the two most decisive factors affecting the tracking performance.

Two Investment Options for Bearish ETF Investors: Inverse ETF and Shorting ETF

A high liquidity, low expense ratio and the possibility to conduct arbitrage allow exchange-traded funds (ETFs) to be used for short sales. Bearish investors can also buy inverse ETFs. This paper aims to outline two investment approaches for bearish ETF investors and the differences between these two approaches; it also aims to examine the relationship between price and an indicator of volume and evaluate the final positions in selected ETFs in selected periods. Short ETFs dominate in simplicity, flexibility, paying out dividends and especially in the limited size of the loss. On the other hand, their structure, which demands daily rebalancing, causes substantial deviation from the benchmark in the long-term and leads to a higher expense ratio, and lower liquidity increases bid-ask spreads. Negative aspects of ETF short selling lie in unlimited loss, high borrowing costs, the need for margin accounts, variability of loan fees and the possibility of a transaction recall by the lender. On the contrary, margin operations enable potentially higher appreciation of capital by generating rebate rates. Our results show that with the decrease in value of the most used ETFs, short interest is growing for those funds where there is a very strong negative correlation implying hedging tendencies. Short selling proved to be a more advantageous strategy in the observed period of market downturn, as well as in 2011–2017, due to negative returns, however, by applying margin trading inverse ETFs turned out to make less losses. Sector-oriented inverse ETFs are the exception, where the largest differences between these two strategies are recorded. However, the final conclusion of the suitability of one of the analyzed strategies depends on the market volatility and the direction of the market itself.

Do leveraged ETFs really amplify late-day returns and volatility?

The design of leveraged and inverse exchange-traded funds (ETFs) has raised concerns that they may exacerbate volatility in financial markets by mechanically rebalancing their portfolios in the same direction as contemporaneous returns. We show theoretically, however, that capital flows can lower ETF rebalancing demand and completely eliminate it in the limit. Using a sample of U.S. equity-based ETFs from 2006 to 2014, we find that capital flows substantially reduce ETF rebalancing demand, even during periods of severe market stress. After accounting for capital flows and standard risk factors, we find that the impact of ETF rebalancing on late-day returns and volatility is economically insignificant.

Leveraged ETF option strategies

Purpose – Leveraged exchange traded funds (ETFs) have become increasingly popular since their introduction in 2006. In recent years, options on leveraged ETFs have been promoted as a means of enhancing returns and reducing risk. The purpose of this paper is to examine the interchangeability of S & P 500 ETF options with leveraged S & P 500 ETF options and to what extent these options allow investors to manage their risk exposure. Design/methodology/approach – With increasing liquidity for these fund’s options, simple option strategies such as covered calls and protective puts can be implemented. This study derives call-call and put-put parity between options on the underlying index and the associated leveraged ETFs. The paper examines comparative measures of return and risk on the underlying indices, along with covered call and protective put positions. Findings – Using the formulations derived, this study shows options on non-leveraged ETFs or on the underlying index can be substituted for leveraged ETF options. Empirical results suggest substituting options on leveraged ETFs with options on the underlying index or index ETF give comparable results, but can differ as the realized leverage ratio over time differs from projected values. Originality/value – This study is the first to the authors’ knowledge that investigates option strategies on leveraged and inverse ETFs of equity indices. It is also the first to derive call-call and put-put parity relations between options on ETFs and related leveraged and inverse ETFs. The results contribute to securities issuance, investment strategies, and option parity relations.

Are Concerns About Leveraged ETFs Overblown?

Leveraged and inverse exchange-traded funds (ETFs) have been heavily criticized for exacerbating volatility in financial markets because it is thought that they mechanically rebalance their portfolios in the same direction as contemporaneous returns. We argue that these criticisms are likely exaggerated because they ignore the effects of capital flows on ETF rebalancing demand. Empirically, we find that capital flows substantially reduce the need for ETFs to rebalance when returns are large in magnitude and, therefore, mitigate the potential for these products to amplify volatility. We also show theoretically that flows can completely eliminate ETF rebalancing in the limit.

Are Concerns About Leveraged ETFs Overblown?

Leveraged and inverse exchange-traded funds (ETFs) have been heavily criticized for exacerbating volatility in financial markets because it is thought that they mechanically rebalance their portfolios in the same direction as contemporaneous returns. We argue that these criticisms are likely exaggerated because they ignore the effects of capital flows on ETF rebalancing demand. Empirically, we find that capital flows substantially reduce the need for ETFs to rebalance when returns are large in magnitude and, therefore, mitigate the potential for these products to amplify volatility. We also show theoretically that flows can completely eliminate ETF rebalancing in the limit.

Are Concerns About Leveraged ETFs Overblown?

Leveraged and inverse exchange-traded funds (ETFs) have been heavily criticized for exacerbating volatility in financial markets because it is thought that they mechanically rebalance their portfolios in the same direction as contemporaneous returns. We argue that these criticisms are exaggerated because they ignore the effects of capital flows on ETF rebalancing demand. Empirically, we find that capital flows substantially reduce ETF rebalancing demand. After accounting for capital flows and standard risk factors, we find that the impact of ETF rebalancing on late-day returns and volatility is economically insignificant. Theoretically, we show that flows completely eliminate ETF rebalancing in the limit.

Crooked volatility smiles: Evidence from leveraged and inverse ETF options

We find that leverage in exchange traded funds (ETFs) can affect the ‘crookedness’ of volatility smiles. This observation is consistent with the intuition that return shocks are inversely correlated with volatility shocks – resulting in more expensive out-of-the-money put options and less expensive out-of-the-money call options. We show that the prices of options on leveraged and inverse ETFs can be used to better calibrate models of stochastic volatility. In particular, we study a sextet of leveraged and inverse ETFs based on the S&P 500 index. We show that the Heston model can reproduce the crooked smiles observed in the market price of options on leveraged and inverse leveraged ETFs. We show further that the model predicts a leverage-dependent moneyness, consistent with empirical data, at which options on positively and negatively leveraged ETFs (LETF) have the same price. Finally, 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.

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.

Ombres et lumières des ETF

Les exchange traded funds (ETF) repliquent un support, ils emettent des titres negocies sur toutes les plateformes et rencontrent un succes croissant. Ils facilitent la gestion de portefeuille et contribuent a reduire les couts de transaction. Initialement, le support etait un indice d’action et la methode de replication consistait a mettre en portefeuille chacun des titres du support (replication physique). Actuellement, les supports s’etendent a toutes les classes d’actifs mais aussi aux strategies (positions inverses ou a levier). Une matiere premiere isolee peut servir de support. En Europe, la replication physique (quasi-replication le plus souvent) a toujours ses partisans avec le pret des titres en position qui genere un revenu complementaire, mais la replication synthetique via des swaps de performance domine.Les ETF se sont developpes en s’appuyant sur les reglementations des fonds d’investissement, puis ont contribue a faire evoluer ces reglementations (assouplissement de l’obligation de diversification, possibilite de recourir aux derives) ou se sont appuyes sur d’autres reglementations (emission de titres de dettes et ETN). Deux produits ayant des comportements similaires du point de vue de l’investisseur pourront etre reglementes de facons differentes et faire appel a des montages differents. C’est le cote mal eclaire de l’affaire.Les techniques de replication peuvent ajouter des risques supplementaires a ceux des supports repliques : risque de contrepartie, situations de conflits d’interet. La replication de certains supports (metaux, matieres premieres agricoles) amene a poser la question du risque de manipulation des cours : les echanges sur ETF peuvent-ils destabiliser les marches supports ? Un renforcement des obligations de transparence et de publication permettrait a tout investisseur d’estimer precisement la valeur et les risques pesant sur ces produits et ameliorerait l’efficacite de la reglementation europeenne.Classification JEL : G23, G28.

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.

Trading Restrictions, Exchange Traded Funds, and Regulatory Arbitrage

As of January 2012, there were 1,155 Exchange Traded Funds (ETFs) with $1.134 trillion in assets and daily dollar trading volume exceeding 35% of total exchange trading. Academics and regulatory agencies are increasingly beginning to investigate the market impacts of traditional, leveraged, and inverse ETFs. The extraordinary growth and innovation in ETFs and a recent spike ETF delistings and liquidations should be of concern to financial market participants. This paper studies the current market for ETFs and specifically examines whether investors substitute ETFs and inverse ETFs for short positions in individual financial securities while short sale trading restrictions are in place. Even though ETFs are the preferred vehicle among short sellers, no studies are known to have examined whether ETF’s are a viable substitute. I find large declines in ETF trading volume (-51%) and large declines in ETF short interest (-46%) suggesting there are impediments to circumventing the ban with ETFs. This suggests trading restrictions in conventional securities had negative spillover effects to ETF markets and adds further evidence in support of constrained short selling, limits to arbitrage, and overvaluation.

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.

On the Performance of Leveraged and Optimally Leveraged Investment Funds

Leveraged and inverse Exchange-Traded Funds (ETFs) have become increasingly popular in recent years and have attracted significant assets. This paper develops a very general mathematical framework for assessing the long-term performance of leveraged and short investment funds based on stochastic calculus. Our analysis allows for multi-asset and cross-asset class portfolios and explains the role of volatility and correlation of the underlying assets for the long-term performance of the strategy. Further, we show that there is an optimal degree of leverage that maximizes the expected future return of the daily re-balanced leveraged investment strategy that depends on observable market parameters. Thus, we develop an improved methodology for leveraged and inverse ETFs that adjusts the degree of leverage optimally to prevailing market conditions on a regular basis.