I just read this at The Motley Fool. It's about the downside of using ultra-short ETF's
"...these ETFs maintain constant leverage. Mathematically, that means that if the underlying index goes up 10 points, and then down 10 points, the UltraShort fund won't break even. It will lose money."
They were touting .com stocks in the late 90s and then reincarnated themselves after the rout. They were initially bankrolled by that 'genius' who founded and rode into the ground AOL, Steve Case. He has a colorful past.
I'm too lazy to find the link but head over to seekingalpha.com and search their database to find an accurate explanation of levered ETFs.
I don't lose sleep over it as REITs continue to teeter. When the decline comes it will produce 20-30% gains over a short, 2-3 week period.
But I think that this "inefficiency" is not particularly material because no one buys an "Ultra" ETF with the intent of it not appreciating in value. So it's a trade-off. The owner of an Ultra ETF is buying leverage to increase his desired gains -- but will indeed lose more money than he'd like if the ETF doesn't appreciate. The most important take-way here is that in the long run, any "2X" ETF will not actually return exactly double -- even it it does appreciate.
Crikey why did you ask that? There goes 10 minutes.
The semantics are: to what does the 10% refer? If 10% up and down both refer to the original price, then IYR and SRS end up at their original prices, with SRS swinging twice as much as IYR swings.
If "10%" refers to the current price, then things get tricky. If P1=original price, P2 is the price after 1 price change, and P3 the price after both price swings: P2=P1-0.1P1 P3=P2+0.1P2 or after substituting (P1-0.1P1) for P2, P3= P1 - (0.1)^2 x P1 The order of the price changes doesn't matter. The amount lost = the square of the increment; for IYR that's 10%^2 = 1% of original amount. For SRS it's 20%^2 = 4% of the original amount. Because of the nonlinearity the losses get worse fast for bigger swings.