Leverage in PA

Does it makes sense to use a little leverage (1.15-1.30x) in your PA if you are just buying index etfs
 

back of the envelope calculations: with about 15-20% yearly stdev on the s&p a 60% drawdown is 3 standard deviation event (i know returns aren't exactly normal but this is an approximation). So with a 50% maintenance margin on 1.15x leverage you need about a 70% drawdown to hit your margin. 

Am I missing something here?

Also how would you rebalance your leverage?

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Comments (16)

Apr 17, 2021 - 7:39am

Don't underestimate the impact of leverage on your psychology. It's easy to assume you will keep a cool head during the next drawdown from your armchair and with the market breaking new highs every day. But next time sht hits the fan, it's hard to stay composed and not sell at the bottom if you have levered up, because all of the sudden the thought of "I could lose it all" becomes a lot more real.

  • Associate 1 in IB-M&A
Apr 17, 2021 - 9:21am

MMPM

Don't underestimate the impact of leverage on your psychology. It's easy to assume you will keep a cool head during the next drawdown from your armchair and with the market breaking new highs every day. But next time sht hits the fan, it's hard to stay composed and not sell at the bottom if you have levered up, because all of the sudden the thought of "I could lose it all" becomes a lot more real.

This. Happens all the time. People say they'll buy the dip but when it dips, it happens for a reason and people get scared/spooked 

  • Prospect in IB - Ind
Apr 17, 2021 - 1:04pm

How would you approach re-adjusting your exposure to maintain a certain certain leverage ratio. It seems that if you choose to rebalance daily, monthly, yearly etc, you are making a bet against mean reversion when rebalancing, ie taking more exposure when the market has gone up and cutting it when it has gone down.

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Apr 17, 2021 - 11:39am

Good advice here generally: it does make sense to lever up, but it takes a psychological adjustment to get used to the dips. It's worth mentioning that you can add treasury bonds as a partial hedge, cutting your volatility a bit. Leverage enables you to get closer to an optimal portfolio from a Sharpe perspective, while achieving higher levels of returns than you'd be able to without some margin. 

As an aside, only IB and Robinhood have reasonably competitive margin rates, as far as I know.

Apr 17, 2021 - 3:13pm

Doesn't it make more sense to add a small component of leveraged etfs to your account to achieve your target leverage rather than buying index funds with margin? Easier to rebalance and you don't need to be scared of margin costs or your account getting called. 

Apr 20, 2021 - 10:24pm

Don't most levered etfs use futures? You lose money when they roll each month. Most are made to track daily moves in the S&P, not over the long-term. 

Apr 20, 2021 - 10:32pm

I thought they generally use short dated options instead of futures but might be wrong. They generally track daily movements so that NAV decrease from contracts decaying is generally offset by the fact that most of these funds are positive more days then they are negative.

I.E. these 2x or 3x funds outperform their given leverage despite fees etc. if the asset they track goes up in a generally straight line. This is cause of the idea that 1.01^10 != 1.10. SPY generally goes up in a straight line before sharply going down so I think these funds are OKish

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