December 8, 2021

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Direxion Daily S&P 500 Bull 3x Shares ETF: A Data-Driven Analysis Of Holding Long Term Leverage Risk (NYSEARCA:SPXL)

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The Direxion Daily S&P 500 Bull 3x Shares ETF (SPXL) is a 3x leveraged ETF that replicates the daily return of the S&P 500 multiplied by 3x. For example, this means that if a daily return of the S&P 500 is +3{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} then SPXL would return +9{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} but should the S&P 500 fall -3{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} then SPXL would fall -9{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942}. SPXL is designed for the most risk-seeking investors that want to triple-down on the S&P 500 gains and able to soak up any large losses that are magnified.

Volatility Drag

Conventional wisdom recommends that leveraged ETFs should not be held long term due to daily rebalancing and volatility decay. A regular 1x leveraged ETF also has volatility decay. This can be illustrated with the mathematical formula for a 2 day compounded return. Let’s say an ETF rose x{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} on day 1 and then fell x{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} on day 2. The final return would be (1+x) * (1-x) = 1 – x^2. The x^2 part of the result is the volatility drag, indicating that even a 1x leveraged ETF will decay slowly over time if the percent return action is flat.

In the case of a 3x leveraged ETF such as SPXL, the formula now becomes (1+3x) * (1-3x) = 1 – 9x^2, meaning the volatility drag effect is 9x higher than for a 1x leveraged ETF. This means that it is not just in bear markets that SPXL would significantly underperform, but also in flat markets.

A Historical Back Test

However, the S&P 500 tends to rise on average, as it is a broad based index with high quality companies. Companies in the index that perform poorly for too long get removed eventually. Other factors such as continued population growth, productivity growth, technological advancements, and inflation all keep the S&P 500 rising higher over the long run.

It’s possible that a 3x leveraged S&P 500 ETF like SPXL could significantly outperform the S&P 500 in the long run, which would dispel the myth that leveraged ETFs should not be held long term. To analyze this, I ran a back test to simulate 1-year forward performance of the S&P 500 vs a 3x leveraged S&P 500 ETF such as SPXL. SPXL was created in 2009 after the Great Recession and thus does not have as much historical return data to evaluate the performance in protracted bear markets. I pulled S&P 500 daily return stats dating back to 1990 so that I could include all three major bear markets in the last three decades.

Some model details to note:

  • I calculate a daily return by taking the close price of the current trading day divided by the close price of the previous trading day which assigns any after-market movements to the current day.
  • A 1-year forward return is the compounded daily returns of the next 253 trading days (the average number of a trading days in a year).
  • Each data point is one day that an investor started investing into the S&P 500 or SPXL and the associated return is the return they would have had a year later.
  • For simplicity, dividends and fees are not accounted for.

Source: Author’s own calculations, S&P 500 price data 1990-2020 from Yahoo Finance

One fear that investors have of investing in SPXL is that their portfolio gets completely wiped out. This never would have happened in the past 3 decades, though it got close during the Great Recession. It’s very unlikely for SPXL to get completely wiped out due to daily rebalancing. There would need to be a single day drop of 33.33{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} or more in the S&P 500. The largest historical one day drop was Black Monday in 1987 where the S&P 500 dropped 20{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942}. There are also circuit breakers in place to halt trading if the S&P 500 drops more than 20{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} in a single day. The S&P 500 could and has certainly dropped 33.33{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} or more over a longer period of time but the daily rebalancing would prevent SPXL from going to zero.

That all being said, it does not mean investing in SPXL won’t crush your portfolio significantly. The protracted bear markets starting in 2000 and also 2008 led to some of the worst returns for the S&P 500 and also SPXL. Investors often already have a hard time staying invested and holding through -30{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} to -40{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} annual returns for the S&P 500 in bear markets. Even fewer investors could hold SPXL through -50{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} to -90{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} annual returns.

SPXL Typically Outperforms But Not Without Major Risk

I calculated the 1-year forward return delta between investing in the S&P 500 and SPXL and plotted the individual data points in a histogram. For example, if the 1-year forward return for S&P 500 was 10{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} but 18{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} for SPXL then the delta is +8{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942}. Note that the 1-year forward return for SPXL is rarely actually exactly 3x the 1-year forward return of the S&P 500 due to daily rebalancing.

Taking a broader look at the data shows that SPXL does outperform the S&P 500 in most cases. Risk-seeking investors who have the guts to stomach the increased volatility of SPXL can really gain from sticking with SPXL long term.

On average, SPXL outperforms the S&P 500 by 18{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} on a 1-year forward return. SPXL outperforms the S&P 500 by any amount 71{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} of the time. There are even times where the 1-year forward return delta between the two is over 200{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942}, which typically happens during bull run recoveries after a protracted bear market.

However, investors should take note of the 29{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} where SPXL can lag S&P 500 by up to 50{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942}. It’s certainly already painful to watch your portfolio fall 40{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} in a bear market and if you were invested in SPXL instead you’d be down over 90{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942}, almost completely wiping out your holdings

Source: Author’s own calculations, S&P 500 price data 1990-2020 from Yahoo Finance

For the investors that are somehow able to stick with the volatility and the near wipe-outs, SPXL would have greatly rewarded them. If an investor began investing in the S&P 500 in 1990 and continually held to today, they would have 10x the amount they invested. If that same investor invested with SPXL instead and held through even the 90{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} draw downs, they would have 63x the amount they invested, six times the the return of the S&P 500. That’s nothing to sneeze at.

Conclusion

SPXL is safe to hold long term but only for investors with the highest levels of risk appetite. Investors who hold SPXL can reap significant outperformance against the S&P 500 in the majority of cases and over the long run.

For most investors, it is better from a psychological perspective to hold the regular S&P 500 ETFs as very few investors could stomach 90{8b976aae6532a1b052a1428c53b0491f6d522f92e84aa53e49f4bfe9bc214942} declines in their portfolio without selling out at the bottom.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a financial advisor. All recommendations here are purely my own opinion and is intended for a general audience. Please perform your own due diligence and research for your specific financial circumstances before making an investment decision.

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