Take Advantage of Large Gains Using Leveraged-ETFs For Longer Periods

Summary

• Leveraged-ETFs (LETFs) use financial derivatives or debt to extend your investment, and there is a wide selection of funds to choose from.
• Despite many news articles claiming LETFs can’t be used for “long-term” investments (greater than a few days), they can be empirically demonstrated to work on longer time frames.
• Using various methods to extend your investments can be a great strategy. You could use a HELOC, SLOC, personal loan, margin, or options contracts, but LETFs pre-package it for greater simplicity.
• Severe bear-markets (such as DEC 2022) are an optimal purchase time with 400–600%+ returns likely.

Note: I have moved to substack. Subsequent articles on this topic will be here: https://axup.substack.com/ — MAR 24 2024

Introduction

Leveraged-ETFs (LETF) take the money you invest from buying shares and “leverage” it. This typically means the fund may use futures, swaps, options, or debt as a way to extend the investment. All of this has the effect of amplifying both losses and gains depending on which way the investment turns. This means that they are highly volatile, which can be a uniquely valuable trait for some investment strategies.

Definitions of “short”, “medium”, and “long” term investments vary by the context and author. For the purposes of this discussion “medium-term” = 3–16 months (roughly), to differentiate it from day-trading, typical option durations, and long-term buy and hold strategies over multiple bear markets.

LETF Myths

There is a great deal of misinformation and “FUD” in the marketplace regarding leveraged ETFs.

Myth: You can’t hold an LETF longer than a day.

“We don’t promote long-term use of these products” … “and the vast majority of investors don’t use them in that fashion.” — Michael Sapir, ProShares Chief Executive

• There is nothing stopping you from holding an LETF for a longer time period. I have personally held them for more than a year, and I am doing so currently. Friends have as well. You buy them just like a normal stock/ETF, and sell them the same way. Taxes were handled just like a normal ETF sale.
• Following the herd is a great way to get sub-standard returns (or worse, a disaster, a.k.a “meme-stocks”), so it is perfectly fine to “not be in the majority”.

Myth: Decay over time, “daily erosion”, and volatility drag, make LETFs poor long-term investments.

• Many investments have built-in costs to take part. When you buy a house you pay interest to the mortgage company to use their money, and make an investment. Would you avoid buying an investment property because your down payment was being “eroded over time” by interest payments?
• If you sell a house, you pay the real-estate agent a commission which comes out of your profits. Would you not sell a house at a profit because you had to pay a commission?
• ETFs have an “expense ratio”, and many people don’t even know it exists (or whether it is low or high) when they purchase an ETF. Mutual funds typically had even higher expense ratios. You probably already have “daily erosion” in your investments.
• If the return on the investment is high, paying reasonable fees to be able to make the investment are worth it. (Think: use a 5% bank loan to invest in stocks with a 20% yearly return = 15% profit.)
• There are always “hidden” aspects in any ETF such as changes in the percentage of what companies it holds and fund expenses. You don’t need to watch the minutia, you need to watch the overall stock price relative to your cost basis.
• Tao Jaxx points out in his Seeking Alpha article that “in a bull market, compounding will run its magic and propel the LETF way above its unlevered kin. So there is indeed volatility decay, but also volatility compounding.” If you buy low, then you can set yourself up for the compounding side of the equation.
• How much erosion do you see in the stock price (versus potential gains) for SOXL in the following 2-yr chart? Also, the 10-yr chart for SOXL trends up, not down.

Multiple (perfectly timed, theoretical) buy cycles are possible.

Myth: You could lose your investment.

• The value of the LETF could go down, but you would still own your shares. As long as you aren’t using margin, there is no one forcing you to sell your shares if they lose 80%+ of their value (which SOXL and FNGU did during 2022, see below). If the worst happens (as it did to me) you can just wait it out. I’m not panicking and you shouldn’t either.
• If a fund reaches a sufficiently low price, it could be de-listed or close. To avoid this, typically ETFs choose to do a reverse-split (to increase the cost of each share). This has no impact on your equity, or eventual profits, but you will own less shares in this scenario. FNGU actually did a reverse-split in 2022 while I was holding it, and I still expect to sell it for a profit eventually.
• There is also a slim chance of an ETF being shut down, in which case you typically get the final (low) value per share. This is extremely unlikely for a sufficiently large fund (check the AUM size of a LETF before investing), but it is a theoretical possibility and a reason not to devote your entire portfolio to this strategy. Also, de-listing is a scenario for any stock, ETF or otherwise.
• Realistically, you own X number of shares, hold them if there is an unexpected bear market and then sell X shares when the market goes back up.
• ”Daily erosion” does not typically decrease the number of shares you will own. It could impact the value of each share, but that is built in to the stock price and is simple to monitor (and easy to review the history of.)
• While most financial advisors would place use of LETFs in the “extreme risk” category, I would actually place them in the medium/low-risk category (a topic for another article), when used in the right situation. Risk is relative and the term deserves a more nuanced usage than it normally receives.

If you make the mistake of buying at a high-point, LETFs can lose a large amount of their value in a bear market, but they can be held until the market corrects itself.

Investment Hypothesis

Investing longer-term in a leveraged ETF isn’t rocket science. Here is the basic algorithm I use. Spoiler: it boils down to BLSH (Buy-low sell-high) using a LETF.

1. Progressively buy-in as the market drops, continually lowering your cost basis.
2. You can sell when the stock value returns to all time high (ATH), or when it reaches X% above ATH, or when your investment gives the desired return (e.g. 200%).
3. Pay your taxes and calculate your net return.
4. Re-invest most of your earnings in something with less volatility (e.g. VOO, VGT).

Simple progressive-buy and sell strategy that does not require market-timing.

It is worth mentioning that not all ETFs are the same. An ETF that targets oil, or travel, or real-estate, is not the same as ETFs that target semi-conductors, big-tech, or the SP500. I personally like TQQQ and SOXL because they are hard-core tech that the future will be built on top of. Investing in oil or gold is always a questionable idea — regardless of whether it is an individual stock, ETF, or leveraged ETF. It is worth looking at the AUM (size or market value) of the LETF. I only invest in funds >500M to be on the safe side and avoid the closure scenario. You can also look at how old the fund is.

Validation

Back-testing

I have algorithmically back-tested quite a few (maybe 1000) variations on the above strategy, and there are certain percentages that work better than others for particular funds, but the general principle is always the same. I use a custom back-testing algorithm developed on Quant Connect. I have watched how these funds behaved in various scenarios (up-market, down-market, different durations, different buy-in percentages, different exit strategies, etc), going back up to 6 years.

Results of back-testing SOXL BLSH strategies.

Needless to say, if I had figured out this strategy earlier, I would be richer now. During previous drops in the market I didn’t know what to invest in, didn’t have sufficient liquidity, and didn’t understand that the market would eventually recover. The strategy I am describing works consistently because the overall market goes up over time, but downturns also regularly occur (although they happen at an unknown time). These present huge opportunities while most market participants are frozen in fear.

Real Money

The cycles for this type of investing are “medium-term” (3–16 months typically), so it takes years to run a series of real-world tests with real money. Before the initial COVID lockdown I conducted two cycles of testing with TQQQ and one with SOXL. I purchased a house with the proceeds. A friend shadowed these investments with her own money, at roughly the same time-frame, and got even better results due to taking more risk (by waiting longer to sell.) I also did similar investments in FNGU and UDOW.

My testing with real money is ongoing. I will continue to update this post as new results come in, so that it will eventually be a longitudinal analysis of sorts. These tests involved a mix of longer and shorter-term strategies, and are not a controlled study with exactly the same algorithm and variables used each time — but they show what is possible.

A selection of real-money tests: (last update: JAN 27, 2023)

A record of tests with real money, periodically updated as new results come in.

Key:
* = Tests with multiple sequential buy-ins
- = Still held, check back for updates
✧ = Much to the chagrin of my financial advisors, I have recently transitioned a large portion of my retirement accounts (Roth 401k and Roth IRA) to leveraged ETFs during the 2022 drop. I will report back on the outcome when it becomes clear.

Conclusion and Takeaways

Leveraged ETFs offer an opportunity for very large gains in medium-term time frames, with a moderate/low risk-profile, which is hard to match with any other investment strategy I have seen. Other authors realize the potential benefits of a BLSH strategy for LETFs during downturns: Great Plains | Sarel Oberholster | Dean Young | Double-digit Numerics

Large returns are theoretically possible with optimal market timing (real example shown). Slightly lesser returns do not require perfect timing and are fairly simple to achieve.

Pros:

• Potential gains of 400–600%+.
• Avoids the risk of single stocks with huge upside (e.g. TSLA) by using a diversified ETF instead.
• You don’t need to “time the market” (just buy when it happens to be low, whenever that occurs, and sell near HH.)
• Simple use of pre-packaged leverage without the hassle or risks of options contracts, personal loans, HELOCs, SLOCs, or margin.
• Volatility is often referred to in a negative light, but it is a desirable trait if you’re looking for multiple cycles or larger profits, and LETFs have it in abundance.

“Despite the high expense ratios associated with leveraged ETFs, these funds are often less expensive than other forms of margin.” — Investopedia

Cons:

• SOXL is diversified, but only in the semiconductor market. If the whole market tanks for some reason, it would have more risk than more diversified LETFs such as TQQQ or UPRO.
• I advise against using margin (borrowed money to buy stocks) to buy leveraged ETFs. I say this from personal experience. LETFs already borrow and extend your money for you. LETFs are highly volatile. During parts of the investment you could lose 80%+ of the value. Adding risk to risk is a bad idea. Margin-calls can be very stressful and cause serious financial problems. Protect your mental health.
• You probably don’t want to hold LETFs across multiple bear markets (due to a number of factors including watching it drop 80% at times, and more profits from selling more frequently), but theoretically there’s nothing stopping you from doing so.

Tips:

• Don’t use LETFs with an AUM of less than 500M.
• Broader indexes are less risky.
• Don’t buy-in at a high point.
• Older LETFs may be less risky than brand new ones.
• Don’t use margin to buy LETFs.

Reader Questions:

• What do you predict will happen to an investment in TQQQ placed in DEC 2022?
• Have you tried “medium-term” LETFs investments yourself? What was the % profit you received?
• Have you found other investment strategies rivaling these returns with a similar risk-profile?

Notes:

• The extended version of this article was originally posted on Medium on DEC 17, 2020 and contains additional detail on misleading LETF media articles.
• Thanks to D for one of the test examples and proofing this article.
• I do not hold any financial degrees or certifications. I am not a tax advisor. Your investment decisions are your own, and it is best to test strategies with small amounts of money first, preferably after extensive back-testing.