Iv been exploring ways to gain a small amount of leverage lately. The problem is margin is pretty restricted, has high costs, and requires a good deal of money to get lower rates. Using options just feels pretty complicated. Leveraged funds though are very cheap comparatively but the big downside is volatility decay and losing money in sideways market.
Recently hit me though that volatility decay happens just because of the reset which is changing the amount you are leveraged over the long term. This can be fixed though just by rebalancing before the reset period.
Going to use some unrealistic numbers here for simple math purposes. This is not a recommendation for 2x leverage over a long period, just for simplicity.
Fund A tracks the S&P500. You invest $100 in it. The first month it gains 25% leaving you with $125. The next month it drops 20% leaving you with $100. Market has gone sideways, you’ve made $0 and matched the market.
Fund B is a 2x version of fund A resetting monthly. You invest $100 over the same period and have $150 after month 1 then $90 after month 2. Fund B lost 10% even though the market was flat due to volatility decay.
Fund B with rebalance: volatility decay occurs with leveraged funds because it decreases leverage during downturns and increases with upturns while using regular margin for leverage does the opposite and has no volatility decay so you just need to match that via rebalancing.
After the first month you jump to $150 like before (25% return 2x). Now though the fund is about to reset and up leverage. To maintain it you’d just sell $50 profit and put it in fund A. You now have $50 in fund A and $100 in fund B right at reset. Fund A drops 20% leaving you with $40 and find B drops 40% leaving you with $60. $100 total.
In summary by rebalancing at the reset period you eliminate volatility decay.
Iv worked this out with different numbers over several periods and it always seems to keep 2x returns regardless of volatility but I’m hung up on how this costs like 1-2% in fees while margin costs more like 5% plus with no added benefit.
Am I missing something here?