I notice that Leveraged ETFs are not permitted in the contest. I think it is possible to produce good risk/return profile using combinations of leveraged ETFs with some active trading. Further, this can be easily implemented in clients accounts without restrictions (without needing a margin account, and hence available to both IRA and non-IRA accounts).
Is there a reason why these are excluded? Is it possible that this restriction can be reviewed in future and relaxed?
Because a fund can only have 3x the leverage in total, and it would be hard to calculate. Say you bought 3x a leveraged 3x fund, thats really a leverage of 9. Altho the account leverage would only be 3.
Its part of Investment Company Act of 1940.
If you make Congress repeal the law, sure, it can be relaxed down the line.
(In theory, you can buy a 3x leveraged ETF at 1x the leverage, but then you might as well leverage the non-leveraged version of the ETF at 3x to get virtually the same results).
Thanks. That is clear from the congress perspective.
I was intending to use 3x Leveraged ETFs without any additional margin borrowing (meaning leverage setting=1). This way a margin enabled account is not needed and the strategy is applicable to all account types (like IRA accounts as well as non-IRA accounts).
Is it true then from the congress perspective a non-leveraged (leverage = 1) fund which uses 3x leveraged ETFs are allowed?
If congress allows that, it is probably just a technical limitation that it is hard to track the total leverage within Q. Can that be addressed and open it up for the contest (a simple rule could be if there is even one 3x ETF leverage cannot exceed 1) ?
As a side note:
A 3x leverage system does not produce the same returns as a 3x ETF mathematically (Say there is a 1% drop for 3 days in SPX then one the one hand we have 3*(0.99^3-1) = -8.91% drop vs 1*(0.97^3-1) = -8.73% drop). Here the 3x ETF has less loss than a total leverage of 3. Similarly, for consecutive 1% gains say the 3x ETF will perform better. So the compounding effect has positive convexity.
(I am ignoring the ETF fees, tracking error for the 3x ETF, and margin borrowing cost for leverage)
Not always, from reg T, the demand for overnight margins are 50% * leverage rate, but to a maximum of 100%. In other words if you trade on margins, you can't have say 50% in this ETF and trade with margins on the rest. Non margin accounts can however have an ETF bought without leverage, that is 3x leverage. Portfolio margins can extend that tho (hench why 3x leverage is allowed, not just 2x), but you will have a hard time finding those that gives you an overnight portfolio margin of 33% or less on a leveraged ETF.
Yes, that is mainly the reason, since you would have to calculate it for each individual stock, their leverage, and the total leverage. But it would also be hard to use your algorithm in a real portforlio. Because Q itself will have leverage, and the margin demands will be higher than 1 if you invest 1. One leveraged ETF with just 2x leverage bought at no more than 1x leverage would be fine.
For the sidenote: Quite true, also ETFs tend to perform differently even if they have the same portfolio. They should however trend at the same direction.
I am a little confused. Can you clarify this please.
If I have a RegT margin account at IB (non-IRA), funded with say $10,000, and I want to purchase UPRO for $5,000 and say CURE for the remaining $5,000, (both of these ETFs are 3x leveraged ETFs) so that I am 100% invested, will I be able to do that? I do not expect to be using any margin in this case. Is that right?
When you say, "One leveraged ETF with just 2x leverage bought at no more than 1x leverage would be fine." does this also apply to one Leveraged 3x ETF (example UPRO) bought with no more than 1x leverage ? I thought I should be able to buy UPRO for the full $10,000 Is that right ? (assuming I do not hold anything else)
I also did not understand why Q has its own leverage and margin demand is higher than 1 if you invest 1. Please explain.
Thanks for your clarifications.
Yes, that is correct, you could however not invest 7500$ in CURE, a single dime would be over your margin limit. Q however will get its margin calculated from ALL the stocks it has, hench why 50% of the value of the ETF * its leverage would reduce your overall leverage limit. So if it runs say 5 algorithms, this margin limit would affect the other algorithms.
Because 2*50% = 100%, 3*50% = 150%, but 150% of its value wont hit the portfolio value cap of 100% if you where to trade multiple alogithms even if your own algorithm is limited at 1 leverage.
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