This data in this post is as of 2/10/25.
On
January 29, 1982, trading began in the Chicago Mercantile Exchange S&P 500
futures contract (symbol ES). This futures contract was designed primarily for
institutional and large speculative investors. (Today there’s the micro e-mini
and many other index futures contracts.)
On January
29, 1993, State Street’s S&P 500 SPDR (symbol SPY) became the first index exchange
traded fund (ETF) which offered indexers the ease and liquidity of regular stock
trading. And finally, on November 6,
2008, a controversial innovation, the S&P 500 Bull 3X Direxion ETF (symbol
SPXL) began trading. SPXL is a “3X fund”, it targets three times the daily
return of the S&P 500 index each day. SPXL may have three times the risk,
but this is where the magic happens!
To
start, let’s compare the 5-year chart for the three liquid index products: SPY
(the plain vanilla S&P stock index ETF), ESn (the continuous “nearby” S&P
500 futures contract) and SPXL (the jacked up 3X leveraged S&P 500 ETF):
Continuously
compounded performance, normalized where 1/3/2020 = 1000.
Table
1
SPY = S&P 500 SPDR
ESn = S&P 500 “E-mini” continuous nearby futures
contract
SPXL = S&P 500 Bull 3X Direxion ETF
Continuously compounded annualized return and standard
deviation.
Source: barchart.com closing prices adjusted for
dividends and splits.
First let’s note the chart has 2 major market breaks, one
in 2020 and the other in 2022. Also note Table 1 in no way shows SPXL (or any
other 3X ETF we look at, for that matter) delivers 3X for extended periods. The
one month is close: 8% versus the 9% target. Going further out the SPXL
definitely has a higher return than the index but the farther out you go, volatility
takes its toll. SPXL’s 1 year 43% is good but far off the 3X 60% target. For
the 2, 3 and 5 years, the gap only gets worse. To Direxion’s credit, the SPXL prospectus
makes no claims for periods over ONE DAY! Even the 3X daily target has no
guarantee. The prospectus does point out the risk that a 33% one day drop in
the index is a 100% loss in the 3X.
Looking again at the chart, SPY fell roughly 30% in the 2020
market break. At the March 2020 low, SPXL was down 70%! You COULD claim that SPXL outperformed, beating
its -90% target, but this was no comfort as we lived it. The 2022 market break
took SPY roughly from up 50% on Jan 1, 2022, to up only 20% by October, a 30%
decline. At the same time, SPXL went
from roughly +100% to -20%, a 120% decline-this time exceeding its 3X target!
Before leaving returns, let’s point out that SPY and
nearly ALL broad-based index ETFs have de minimis tracking error. They are
excellent proxies for their underlying indexes. Also note that the index
futures contract lags the index generally in all periods. This is due to the
cost of maintaining a futures position-rolling futures from the March contract
to June, to September and finally the “Christmas” December expiration month and
so on.
We see the risks, let’s see the magic!
To see this, assume you throw caution at the wind and
recklessly want to maximize your exposure to the S&P 500 stock index with
the least amount of cash possible. The E-Mini S&P 500 futures contract value
equals $50 per point ($50 x 3642.25 =) $182,113. The “exchange minimum margin”
on January 3, 2020 was $6,300. $6,300 controlled $182K! This is insane 30X
leverage! If the E-mini falls 126 points, you are wiped out. But long before
that happens, your broker will give you a margin call or sell you out. Or, more
likely, will NOT honor exchange minimums and demand a much larger initial
deposit.
Next, you buy $182,000 SPY on maximum 50% margin, borrowing
half of the purchase and paying half in cash or $91,000 . Finally, buy $182,000
worth of SPXL. Since this is 3X, you cannot buy on margin but your $60,000
purchase allegedly controls $180,000.
Table 2
In Table 2, we see the market price and starting account
value for each of our investment comparisons.
Table 3.
In Table 3 we assume the investor holds their ETFs or
rolls their futures and meets ALL margin calls with no withdrawals from the
1/3/2020 start date to the current 2/10/2025 end date. Commissions and interest
not included.
Here comes the magic! While the returns are all roughly
the same, leveraged futures and marginable stock have the risk of margin calls.
Your 3X ETF will have NO MARGIN CALLS no matter where the market goes. Due to
the hocus-pocus of 3X money managers, 3X can give you a dollar certainty the
other choices cannot. You are one and done with 3X. You are one and maybe many
margin calls- not done- with the others. In the end, the total dollars for futures
and 3X, were not much different (roughly $60K) nor did they affect the returns.
But on day one, who knew? While not an endorsement of 3X ETFs, take this as an
illustration of the three basic ways to leverage a position.
Caveats: these kinds of results can only be expected with
the broadest based index products with the lowest tracking errors. The more
exotic the underlying or complex the product is, the greater the variation in returns.
Why volatility affects total return is for another article.
