You might have noticed a little sell off last week. On Thursday November 5th, markets sold off hard, and the Nasdaq 100 -- most commonly tracked by the Invesco QQQ™ ETF, QQQ. (Yes, the legal name of the fund includes it's own ticker) closed down over 6%.
One of the things that happens on a big move is that any geared funds -- anything from 1.2X to 3X to their inverse versions -- has to also make some big buys or sells. So when something as trader-friendly as the Qs is play, the street learns the story pretty fast. By 3:30, here's where the smart money on #FinTwit was headed:
So who's right here? Morgan Stanley saying "$50bn in selling to come!" or Jay Dilks saying "Buying opportunity!"
Let's do the numbers. Let's look very narrowly just at TQQQ (the 3x ETF from ProShares) and it's sister, the short version, SQQQ.
Both funds had to be substantial sellers into the close. It tends to break peoples brains that both the long and the short ETF have the same trade, but here's the simplest chart I can make with Claude to illustrate it:
TQQQ started Thursday with $33.54 billion in net assets (the biggest fund in our leveraged/inverse universe.) Since it's daily mandate is 3X, that means the fund had to have $100.61 billion of notional exposure (through swaps). Then the Nasdaq-100 fell 6.3556%.
Applying that move to starting exposure leaves $94.21 billion left over in the swap. But TQQQ's actual NAV fell 19.0969%, shrinking the actual AUM of the fund from $33.5 billion to just $27.13 billion. This is a real problem for the portfolio manager, because they know the next morning, when the circus starts all over, they only want to be 300% exposed. Now just a $27.13 billion fund, they only need $81.39 billion in exposure tomorrow.
That's a $12.82 billion lightening of exposure, sometime between roughly 3:30 and the close.
SQQQ has the same problem in reverse. It started with $1.83B in assets, and thus negative-$5.4 billion in exposure. The fund crushed it, rising over 19% on the day (as you'd hope!), bringing new AUM to $2.18 billion, and thus needing negative-$6.53 billion in exposure. The implied net sell for SQQQ is another $1.4 billion.
So, two funds, going different directions, both making the sell off worse, at the margin.
Buying the Dip?
Back to the original tweet from Jay here... does that mean you should buy the dip?
In general I'm skeptical. Here's the two big indexes going into Thursday's close:
I can't perfectly tie the last-minute selloff to the tape getting wind of the levered complex trade. Everyone knows about it, it's easy to calculate, so there's never a surprise. It's just a question of how baked into the end of day trading prices the known-accelerant is at any given point in time. Personally, I think that's impossible to call: the Qs could have rallied into the close because Mercury entered retrograde, who knows.
But Jay's definitely right that there's plenty of liquidity at times like this. And lots of folks were playing along with Jay. TQQQ had $840 million, roughly, in new flows on Thursday, meaning the selling could have been a lot worse. In that sense, ETFs in general and the levered complex in specific can -- sometimes -- act as a shock absorber. Dip-buyers in the ETF meant that some number of billions never hit the tape as actual "sell NVDA" orders.
And they did it pretty efficiently. In terms of slippage, three times the index's decline was 19.0669%. TQQQ's NAV did just 3 basis points worse. And in terms of market movement, TQQQ's official market close on Thursday "only" booked down 18.91%. That beat the NAV return by 17.82 basis points as its developed a small closing premium.
Is this Good? Is this Bad?
All told, it is absolutely the case that the geared-ETF complex contributed to the Thursday selloff. That's just math:
The presence of these products, I could argue, increases end-of-day volatility. But I'm not willing to get out the pitchforks. Levered bets on indexes and hot-trades aren't new, aren't illegal, and definitely aren't going anywhere. While I personally haven't touched levered ETFs, if I was a day trader somewhere, I absolutely would -- they're where the hot-trades meet the hot-money. If they didn't exist, I suspect much of the same leverage would still end up in portfolios through margin borrowing and derivatives.
So, screwing my optimism cap as hard onto my bald head as I can, the enormous benefit to all investors of having this leverage in ETF wrappers is precisely the transparency that allowed me to even chase down the math for this! That transparency is always a boon for the end investor.
It's the leverage in the system that you won't find in tweets we should probably worry about.
