Tuesday, July 28, 2009

How are SPXU and UPRO Being Traded?

Yesterday, I did my best to be provocative in Is the VIX Being Artificially Depressed by Increased Use of SPXU? One of the points I made is that SPXU could be a substitute for SPX puts (and perhaps artificially depress the VIX as a result) for those who are looking for leveraged ETFs as possible portfolio hedge. To be perfectly frank, I do not believe there will be substantial demand for SPXU (or any of the triple ETFs) as portfolio hedging vehicles, largely related to the issue of the compounding effect (see Understanding the Impact of Changing Market Exposure on Leveraged ETFs from Direxion for more details.)

In fact, when I predicted a bright future for SPXU and counterpart UPRO in The Next Big Thing? back when they launched a month ago, I envisioned three primary uses for these triple ETFs:

  1. As a speculative short-term trading vehicle, with particular emphasis on day trading
  2. As part of various pairs trading schemes
  3. As part of the many arbitrage opportunities presented by all the large and growing family of SPX-based derivatives (futures, options, ETFs, leveraged ETFs, etc.)

While I did not envision SPXU as a viable hedging vehicle, this is largely because I was thinking in terms of a longer time frame for the hedge. If SPX puts can be utilized in increments of the one month options cycle, SPXU would be at a disadvantage trying to compete on a monthly time frame. I do believe, however, that SPXU can be a viable hedge for more than just a single trading session or an occasional two day sequence, as many have suggested. Depending on volatility levels, SPXU hedges can be left in place for up to three days with minimal risk of losses due to compounding. In my opinion, only when holding periods start to exceed four days does an SPXU hedge start to become inefficient.

With SPXU already having traded 2.3 million shares as I type this, the success of this product is now assured. While the value of SPXU as a hedging instrument pales in comparison to other possible applications, I do think SPXU can be used as an effective hedge for periods of 2-3 days at a time with an acceptable degree of compounding risk.

[source: BigCharts]

Disclosure: Long SPXU at time of writing.


Eric said...

So, could this explain why we are seeing 5-6% moves that are divergent from the SPX:VIX inverse correlation?

Position: Short USD (Semis) at the close.

Anonymous said...

Well, nowadays are ETF, but in the last 20 years, have appeared products to hedge or they experimented a dramatic increase of volumen. You can choose a x3 inverse ETF to hedge, but also the sp500 future increase the volumen dramatically and ppl could use it for hedge. how this last fact changed the vix?

In the post before this one, you say the similarities between vix after 87 and this year.

Sure, other products can change the significant levels of the Vix, but the important thing is that patterns continue existing in the Vix, levels are always relatives.

I will continue loving the Vix, as far as give me spikes in the market bottoms.


TV107 said...

dont u know about the decay??
you're supposed to short upro and not go long spxu

The Small Fish said...

Interesting read related to this subject: http://quantivity.wordpress.com/2009/07/28/leveraged-etfs-market-close/

Bill Luby said...

I agree that volatility decay argues for shorting a +3x ETF (if they are available to short) instead of going long a -3x ETF, but for reasons of availability or otherwise, the -3x volume generally exceeds the +3x volume for all triple ETF pair, including SPXU and UPRO.


Anonymous said...

You are so interesting! I do not believe I've read anything like that before. So good to find somebody with some genuine thoughts on this subject matter. Seriously.. many thanks for starting this up. This web site is one thing that's needed on the web,
someone with a bit of originality!

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