ETHU: Volatility Means It's Simply Not For Holding, Only For Trading

Summary Leveraged ETFs like ETHU are designed for short-term trading, not long-term holding, due to their volatility and capital decay over time. 2x Ether ETF aims to provide 2x the daily bull return of Ether but suffers from performance degradation in volatile markets. The fund's design and purpose make it suitable for day trading Ether prices, but not for long-term investments. Understanding the specific purpose of investment instruments is crucial, as using them incorrectly can lead to significant losses. The Right Instrument for the Right Task Matters Any specific instrument is designed for a purpose. We acknowledge this in other areas of life—an 18-wheel semi is designed to haul freight, not to pose along Sunset like a Ferrari, even as both are internal combustion vehicles—so we should grasp the basic lesson in investing as well. Certain instruments are designed around specific problems and attributes. Therefore, we need to use those instruments—if we're going to use them at all—according to those designs. And make darn sure that we're using the appropriate investment for our own goals. 2x Ether ETF ( ETHU ) Now, crypto might not be quite the right investment to take advice from me upon. I'm the guy who insisted at Forbes back in 2011 that that's the end of bitcoin then . If you're going to go wrong, then go wrong big, is my motto. But this here isn't in fact something about crypto, or ether, not really. This is about the instrument, ETHU, and whether it can be used. If it can be, how should it be used? Fund Performance ETHU stock price (Seeking Alpha) Hmm, well, that's not good. The SA calculator doesn't seem to be working today, but that's a roughly and near 90% loss there. In, umm, a year. Under, just. So, not good. But of course, it could the that the underlying has just had a bad time: Ether price (Google) And, well, yes, that's not a good performance. But, from that peak last June, it still is only a 47% loss. One little side issue—it was only last spring that the SEC allowed ETFs to hold, or to be leveraged and track—crypto. So, as we might imagine, there was a little run-up in the crypto prices given how much ETFs were going to increase the prices of the underlying which then all so apparently, well, didn't happen. Our little lesson for the day in that grand lesson of financial markets, the efficient market's hypothesis. Information that is known is already in market prices. It is *new* information that changes market prices. That ETFs would enter crypto was known, so that was already in prices. After ETFs entered, well, the excitement fell away a bit. But that's not quite the point. A 2x bull ETF will, of course, lose more value than the price of the underlying. Which is, as I say, not quite the point. The ETF Warning The ETF promoters themselves, Volatility, say : The Fund presents different risks than other types of funds. The Fund is not suitable for all investors and should be used only by knowledgeable investors who understand the consequences of seeking daily leveraged (2x) investment results, including the impact of compounding on Fund performance. The Fund is intended to be used as a short-term trading vehicle. OK, and there's this: The Fund does not invest directly in Ether. Instead, the Fund seeks to benefit from increases in the price of Ether futures contracts for a single day. Both are important. The Effects of Volatility The first thing to grasp is that leveraged ETFs in a volatile underlying suffer from a basic problem. So basic that Seeking Alpha warns against it : For example, consider the example of a 3x leveraged ETF where the benchmark rises from 100 to 102 (+2%) on day-1, and falls from 102 back to 100 (-1.96%) on day-2. The benchmark index is back to its original level of 100, so has flat performance. For the leveraged ETF, however, the return would be negative. To illustrate, after the first day of trading, an initial $100 investment on a 3x leveraged ETF would rise to $106. $100 initial + (($100 x 2% index return) x 3) = $106 The next day the 3x leveraged ETF would drop 5.88% (3 x -1.96%), resulting in a value of only $99.77. $106 - 5.88% = $99.77 Even though the benchmark index was flat, the leveraged ETF would have resulted in a loss of -0.23% over these 2 days. $99.77 - $100 initial value = $-0.23 Even the SEC warns against it : Leveraged and inverse ETFs typically are designed to achieve their stated performance objectives on a daily basis. Some investors might invest in these ETFs with the expectation that the ETFs may meet their stated daily performance objectives over the long term as well. Investors should be aware that performance of these ETFs over a period longer than one day can differ significantly from their stated daily performance objectives and may potentially expose investors to significant and sudden losses. Now, There Are Benefits On a recent piece here it was pointed out to me—note that you readers always know more, in aggregate, than anyone writer will ever know, which is why I always advise other writers to read the damn comments on their pieces—that yes, it's true. A straight investment in the underlying will produce better results than investing in a leveraged ETF for exactly this reason. On the other hand, tax protected accounts tend not to allow leverage. So, in those, it might be worth gaining access to the leverage at the expense of the performance degrade. But do note that it depends—what it depends on is what follows. This Volatility Degradation More commonly called beta. Again, another recommendation for reading widely. This piece here at SA gives an elegant demonstration of the math here. Do read it. It's by a quant analyst with a background in computer science, so the prose isn't as sparkly and perfect as that here, but the math is a great deal better. The point to take away is that the greater the daily volatility, then the more the drift or degradation in performance produced by the leverage and the daily reset. Something that potters along in the one direction day by day hardly differs from it, something that gets to the same destination but with a great deal of volatility along the way will suffer horribly. Crypto is volatile on a daily basis. Leveraged ETFs on crypto are not the way to follow along in the medium to long term. Despite the leverage/tax privilege issues. One More Thing This line: "increases in the price of Ether futures contracts for a single day" Any form of derivative has a time value to it. We're taking a bet on what the price will be at some point in the future. Obviously, some of the value of that bet is how long do we have in that time part of it? Equally, obviously that time value is greater the more volatile the price we've got a bet upon. Something that varies between 1,003 and 1,005 will be cheaper to buy a bet upon for a day than something that regularly goes from 80 to 120 in a day. So, volatility costs us when buying options. Which means that if we're in a fund buying options then the more volatile the underlying, then the more time value is being lost each day. This is then another problem over, ha ha, time. Finances The accounts of the fund are here . Really nothing very interesting because the important line is just: CME Ether Futures Sept 24 Contracts 1,688 Total $212,899,000 Unrealized Appreciation (Depreciation) 09/27/2024 $(11,164,845) So, they've bought Ether futures. Which at the balance sheet date are losing money. Well, OK. There's some cash, some short-term Treasuries and those futures positions. Not wholly interesting. Or, in more detail : ETHU holdings (Volatility Shares) As of yesterday, NAV was just off the above share price at $32.53. It doesn't vary far from NAV. Which is as it should be, of course. The spread's not bad either: "Median 30 Day Spread 0.20%" That's OK in a trading instrument. The total fund size is some $420 million or so (either AUM or market value they're so close) so we'd be—as the private investors we are—be able to move in or out in what would be to us size. So, pretty good in one sense, terrible in another. Which Is Where We Come Back to Instrument Design There's nothing wrong with ETHU. As long as we're using it for its designed purpose. Which the promoter, Volatility, has already told us. This is for day trading of the Ether price. It is not for a long-term hold. The very volatility of the Ether price itself (plus that achievement of the leverage through futures) means that the capital decay over time is simply too much for it to be used that way. So, if we've a position in Ether that we want to hedge, or perhaps we simply want to speculate—with leverage—on the Ether price that day, then ETHU is just fine to do that with. It's what it is designed for, it's what it's meant for. But that exact design is what it's not suited to long-term holdings. Ether itself is too volatile for a leveraged ETF to make sense as a holding vehicle. Why Am I Wrong? In the idea that we should use instruments according to their construction, I'm not. It could also be that Ether sets off on a one direction tear without volatility, in which case the leveraged nature could make more sense. But without that, it's just not the right vehicle for long-term holdings. My Opinion Well, given what I'm on record as saying about Bitcoin (hey, go big when you go wrong) tomorrow's direction of Ether isn't, perhaps, what I should advise upon. But again, that's part of the point here. Ether is highly volatile on a daily and weekly basis. Which is what makes a leveraged speculative tool interesting, obviously enough. It's also what makes advice about which way it's going to go impossible to give. As a tool, ETHU is just fine at what it claims to do. Give 2x the daily bull Ether return. Now, whether we want to be in Ether, or bull or bear tomorrow, well, that's another thing.