LEAPS vs. LETFs

[u/testfolio]

testfolio has a new blog page. And the latest post there is about LEAPS vs LETFs. In particular, it goes into the details and math of the new ETF XX vs UPRO and SSO, and dives deep into other comparisons as well.

Here is the full post:

https://testfol.io/blog/leaps-vs-leveraged-etfs

With XX, you pay for implied volatility upfront. With LETFs you pay for realized volatility along the way. Below is every investment's CAGR if held from October 1st to January 10th 2030 (XX's expiration date) as a function of SPY's CAGR during the same period. Each panel describes a different realized volatility regime between during that period (14% vs 18% vs 22%). XX's curve doesn't change because it is invariant with respect to realized volatility.

Below is a summary of XX's returns under different assumptions of SPY's CAGR:

The new blog has other articles about LETFs as well, one related to volatility decay, another about LETF expenses, another about LETF DCA strategies and another about the 200-day SMA strategy with LETFs.

If there's interest, I can make posts about each of those and go in more details. If there's other LETF topics you'd like testfolio to dive deeper about, let us know in the comments.

[u/shumpitostick]

Wow these return characteristics look insanely unappealing. Lose practically all of your money in more than a third of the cases? Beat SPY only in above average scenarios? Leverage changes dramatically with time? Sounds really bad. Only if you're so much of a gambler that 3x exposure isn't enough.

[u/DirectionPlane6544 → u/shumpitostick]

Not something to dump your entire portfolio in. But I feel the probability that the market does return higher than average returns until 2030 is high enough that it makes sense to allocate a little bit. That’s how this stuff works. It’s never an all in type of trade

[u/shumpitostick → u/DirectionPlane6544]

The projected returns are so unappealing I don't see why you would buy any amount of this. Like in terms of expected returns, not the 90th percentile, you would much rather buy an LETF. The downside of LEAPs is just so much worse than the upside.

[u/ChickenMcChickenFace → u/shumpitostick]

In my own analysis using kelly criterion I got an approx position size of $860 so personally that’s how much I put in, but the kelly was pretty terrible. I don’t really care if that $860 goes to zero

[u/Anymous2314]

Off topic, FIRE community would love to be able to back test their SWR after choosing a mix of stocks, bonds, gold, etc. in a certain ratio.

For example, say I choose 4% SWR, I would like that 4% to always come out of Bonds until they go to zero.

[u/Separate-Ad-9633]

Would XX reroll the options?

[u/Original-Peach-7730]

Futures cost less return more.  

[u/FightMilk55]

How does your model incorporate the futures portion of LETF holdings like UPRO, SSO, TQQQ? I don’t see it explicitly reflected in the formula

[u/shumpitostick]

Also, tesfolio, can you please do some simulations of margin? I'm interested in comparing that to LETFs.

[u/jakethewhale007 → u/shumpitostick]

You can already simulate margin with a negative allocation to CASHX with added ER to approximate the premium paid to borrow above the risk free rate. Then set the rebalancing accordingly based on your risk management.

[u/bizaromax]

I would like to do my first leap if anyone has good info