Personal Finance & Money Asked on July 8, 2021
It seems to matter for the following, if the increase or decrease happens evenly over 30 days vs if it happen overnight, for the case of Account 1, but does not matter for Account 2. So what if (1) it is a little bit evenly over 30 days, and (2) if it happens overnight, such as from Jan 31 to Feb 1, it increases 100% overnight, and the drop from Feb 28 to March 1, also overnight?
Let’s say, if I have $100, and invest in
Account 1: QLD, which is 2x QQQ
Account 2: QQQ but I borrow the max and can buy $200 worth of QQQ
Now it is Feb 1, and QQQ rises from $100 to $200. So how much money are in my Account 1 and 2 on Feb 1?
And now it is March 1, and QQQ drops from $200 to $100.
How much money are in my Account 1 and 2 on March 1?
Account 1 could have $0 now because it dropped 50% and the 2x effect makes it go to $0.
Account 2 could have $100 now because QQQ just went up and back down to where it was at first. It is as if nothing has happened (except a little bit margin interest I have to pay), and I am back to where I was: $100.
Is that how it is? Account 1 has $0, or does it have $100 like Account 2, or what does it have?
(I think this may have something to do with "rebalancing", as the leverage ETF seems to have "daily effect"… but how does it happen? The fund manager doesn’t just speak "rebalancing" and it can magically happen. He has to do something. What does he do and what is really happening? And the real question is, on March 1, how much money is in my Account 1 and Account 2?)
The question cannot be answered for Account 1, because it depends on the sequence of daily returns of QQQ. The monthly return of QLD cannot be inferred from the monthly return of QQQ. QLD would not go to zero unless QQQ dropped 50% in a single day.
You can explore scenarios for QLD yourself by compounding 2x daily returns. To address the two special (unrealistic) cases you asked about:
If QQQ returns are very smooth (same small percentage move each day), then QLD will approximately vary with the square of QQQ. (This is because returns are geometric and the exponent is being doubled.) So, with QQQ rising smoothly in January, your QLD is worth ~$400 on February 1, and with QQQ falling smoothly in February, your QLD is worth ~$100 on March 1. The exact numbers will be different (worse), because doubling or halving in a month is not that small a daily return, and time decay will come into play.
If QQQ is flat except for making its entire move on one day each month, then the 100% rise causes a 200% rise in QLD, and the 50% fall causes a 100% fall in QLD. So your QLD is worth $300 on February 1 and $0 on March 1.
For Account 2, ignoring interest and trading costs, the value is $300 on February 1 and $100 on March 1.
Answered by nanoman on July 8, 2021
Account 1 would have $100 minus the decay that is inherent to holding an inverse ETF or leveraged ETF. Let's assume that the decay is $28 after two months. $100 minus $28 = $72
Account 2, assuming that there was no margin call while the stock dropped 50%, would have the full $200 that you started with, the $100 debt and some interest charged. $200 - $100 - $1 = $99
Answered by Orange Coast- reinstate Monica on July 8, 2021
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