What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing before we get into the video. Keep in mind that we are not financial advisors and this video is, for entertainment purposes, only make sure to do your own research and consult with a professional before making any investment decision on this channel. We've talked extensively about leveraged etfs and the potential risks and benefits associated. We put a link to our first video on the topic in the description below in our previous videos about leveraged etfs.

We were talking about leveraged etfs for stock market indices, such as the s, p, 500 or nasdaq queue index. While these products are very risky, they can have tremendous upside potential, so may be appropriate for some sophisticated investors. It's been brought to our attention in the comments section that many investors play more exotic, leveraged etfs such as boil, which takes leveraged positions on natural gas futures leveraged etfs linked to commodity prices, are very different from leveraged stock etfs in many ways, they're far more risky And are probably not suitable for most investors in this video we'll take a deep dive into how leveraged commodity etfs work and how they differ from leveraged stock etfs. The pro shares ultra bloomberg, natural gas etf with ticker symbol, boil seeks daily investment results before fees and expenses that correspond to two times the daily performance of the bloomberg natural gas index.

If you're bullish on the price of natural gas, this might seem like a great way to get leverage exposure. However, it's important to note that the boil etf does not directly own any natural gas. They instead take positions in futures contracts that have a payout based on future changes in the natural gas spot price. Therefore, its performance should be expected to differ materially from the performance of the spot price.

To understand this, we'll look at a hypothetical example say there is a major hurricane that causes many natural gas cargo ships to sink these ships were expected to deliver their loads. A few weeks from now, based on this information, you to do spot prices of natural gas. Will rise significantly in a few weeks because there will be less available supply based on this information, you might buy shares of boil hoping to benefit from the price increase, but the supply distribution is well known by traders in the futures market. In anticipation of the shortage, they bid up prices of the futures contracts, even if the spot prices rise over the next few weeks.

Your position in boil may not rise at all because you initiated the position after the news was already priced in now. Let's suppose that you're not trying to make a short-term trade on natural gas, but you believe that natural gas prices will rise over the next five years. For whatever reason, as we will see, you generally don't want to be holding a leveraged commodity etf for a long period of time. The main reason for this is volatility.

Drag leveraged etfs rebalance their positions every day to maintain the daily leverage ratio. If the underlying asset has a tendency to mean revert, this will cause a volatility drag which degrades your returns over long periods of time. We can see this in a simple example. The underlying asset is represented by the blue line.

It goes up a little one day and down a little the next by the end of the period, it's pretty much at the same value that started out at the orange line represents the leverage etf, which multiplies the daily return by three. As you can see, its value has decayed significantly over this time period. Many people call this a volatility drag, but it should really be called the mean reversion drag. Random volatility will not cause this type of decay.

There has to be a daily tendency to mean revert. That means updates tend to be followed by down days and vice versa. The stock market does have a tendency to mean revert, but the tendency is very weak. The strong gains of the stock market have overpowered the volatility drag and the spxl etf has increased almost 30 fold since 2008, but this has not been the case for commodity etfs.

The leveraged natural gas etf has lost 99.88 of its value since its inception in 2011.. If you put in a 36 thousand dollars investment, it would have decayed to just 45 dollars. Other commodity etfs have had similarly lousy performance. The uco leveraged oil etf has lost 99.71 of its value since 2008..

If you put in a 25 000 investment, it would have decayed to 71. So why is it the case that the leveraged stock market etfs have done so well, while their commodity counterparts have been a complete disaster, it can partly be attributed to the fact that the u.s stock market has far outperformed most commodities markets over the past 10 years. When the underlying asset is going up, this obviously helps to leverage etfs stocks tend to go up over time as companies make profits which they can use to either return to shareholders or reinvest in their businesses. Commodities have no such tendency to increase in value, unlike businesses, they do not create anything.

They just exist while it's a pretty safe bet that the s p 500 will be much higher 10 years from now. There's no particular reason to believe that the real price of any commodity will increase in the long run, but there is also a far more fundamental reason for the underperformance of the leveraged commodity etfs by their very nature, commodities have a very strong tendency to mean reverb. If oil is 100 per barrel, all the oil companies will deploy billions of dollars to build new rigs and take advantage of these high prices. The increased supply will cause prices to drop back down to more normal levels.

Even if this takes many months to happen, the futures markets will price this in almost immediately. Conversely, if oil is only 25 dollars a barrel, the oil companies will cut back on their supply and delay their new exploration projects. This will cause prices to rise to a more normal level, and this is true for all commodities. They can experience extreme volatility, but they always tend to revert back to their long run mean, as we've shown with the simple example mean reversion is disastrous for leveraged etfs.

The main reversion makes it almost impossible for leveraged commodity etfs to increase in value over multi-year periods. If you have a long view on a particular commodity, the safest way to play it is by buying the stock of companies in that industry. If the price of the underlying commodity goes up, the company's profits will increase with it, which will boost the share price. Unless you personally own physical storage facilities, it's generally impossible to take a direct position in a commodity with a few exceptions.

Commodity etfs do not own the physical commodities and instead own futures contracts. This is true. Even for non-leveraged products, for example, the uso oil etf is still down 46 from the pre-pandemic levels. This is despite the fact that the spot price of oil has actually more than completely recovered from the pandemic lows at its current price of 68 dollars.

West texas intermediary is 28 above the pre-pandemic level, but this doesn't necessarily mean that you should shun commodity etfs all together. If you have a high risk tolerance and are willing to do your own research, then there is a way that you can use the main reversion decay to your own benefit. If you have a bullish view on commodity, you could shorten inverse leverage etf, keep in mind that nothing in this video is financial advice and we're just pointing out an observation. The pro shares, ultra short bloomberg crude index or sco, is a two times leveraged inverse oil.

Etf, since its inception in 2008 is declined, 92 percent. During the same period, the spot price of oil has been roughly flat. The negative returns of the seo come mainly from the mean reversion decay. If you think the price of oil will go up in the future.

Shorting seo may be a great way to play this. You would benefit from the price rising, as well as the decay of course, with great returns also comes great risk from 2014, through 2016 oil prices, tanked and seo skyrocketed by almost 700 percent. If you had any meaningful short position, this would likely have triggered a margin, call and wiped out your account. Alright guys that wraps it up for this video.

What do you think about leveraged etfs? Let us know in the comments section below, if you enjoyed this content, make sure to smash the like button and subscribe. So you don't miss future uploads as always. Thank you so much for watching and we'll see in the next one wall, street millennial signing out.