Luck's Role In Leveraged ETFs

November 02, 2017

I get a lot of emails from ETF investors. And for every email I get asking what seems like a simple question, I always assume there are 1,000 other folks out there asking the exact same question.

With permission, I wanted to answer one of these emails publicly. I’ve paraphrased the question here for length:


I have bought and sold the Direxion Daily S&P 500 Bull 3x Shares (SPXL) since end of August 2017. I kept the first purchase for over two months and then sold and bought more again.

Question 1: The balances in my portfolio match the prices of the shares on the days they were bought and sold. Are expense ratios, fees, etc., included in the purchase or sale market prices, or will they be charged at a later date? If so, what is the percentage and when?

Question 2: What is the reason that analysts advise very-short-term trades for this ETF? They say this ETF should be traded for only one day; why so? I am watching my account on a daily basis and have a sell stop quote on my shares in case large losses take place when I am not looking, so why should I be afraid to trade SPXL?”

Both of these fall cleanly under an umbrella of “things we take for granted.” The “we” in this case being “ETF nerds like Dave.” And the amazing thing is that the two questions here are actually both incredibly simple, and surprisingly subtle.

Is An ETF A Stock Or A Mutual Fund?

Let’s take the first one. The short answer to the question of “when are fees taken out” is “at the end of every day.”

But that’s not actually intuitive. From an accounting and structural perspective, most ETFs are just mutual funds under the hood. Like a mutual fund, they have a net asset value (NAV) that’s calculated every day by a fund accountant.

That calculation is also pretty simple: You take all of the assets of the fund, and you subtract all of the liabilities. Then you divide the big number by the number of outstanding shares.

What gets tricky is that assets and liabilities are constantly changing. Sure, the value of the stocks the ETF holds go up and down, but an ETF is just a company, from an accounting perspective, so every day it also has some small amount of income, from things like dividends or maybe securities lending, and expenses, such as what the fund owes the fund manager.

So every day, what the fund is owed, and what the fund owes, is taken into account in that NAV calculation. The fund might only cut a check to the fund manager once a quarter, but every day, the amount owed for that day’s management is counted as a liability, no matter how small.

What complicates things is that ETFs, unlike mutual funds, don’t trade at NAV. The end-of-day calculation simply serves as a benchmark around which the rest of the market decides what to bid or ask for shares in the open market. And of course, that moves around all day during the trading day, based on how the holdings of the fund move.

But ever so slowly, that benchmark slides downward as the expenses are accounted for, day after day. If the markets were literally completely flat on a given day, you’d expect the price of every ETF to go down just a fraction of a fraction of a percent.


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