The Nasdaq (QQQ) is consistently the best performing US stock index due to its concentration in mega-cap technology stocks, with a 50% exposure to the information technology sector. Shorting QQQ is risky – not only does it require excellent timing, both on entry and exit – but the potential losses are limitless.
Leveraging a short position in QQQ through an ETF such as the ProShares UltraPro Short QQQ ETF (NASDAQ:SQQQ) may amplify the risk 3x, but it does have the advantage that you cannot lose more than your initial position. A trade in SQQQ can be treated similarly to an option: if it doesn’t work quickly, it will likely trap you in an unrecoverable loss and go to zero (or very close to zero). As long as this is factored in to a trade plan, either through position size or a stop loss, SQQQ does provide a useful way to gain 3x inverse exposure to the QQQ. While many will focus on the horrors of its long-term chart, let’s not forget its H1 performance two years ago was +129%.
Risks
While SQQQ returns in H1 2022 were impressive, you would have had to close the position promptly with a great deal of skill (or luck). If you had held two more months, the gains would have evaporated to only +16%.
If you’d held longer into 2023, losses would quickly snowball. There is simply no way to recover losses if you hold SQQQ long-term.
Even a 6-month hold in the current environment would be very difficult to recoup.
A -46% loss would need an 85% rally to break even, which neatly illustrates the dangers of negative compounding in an inverse ETF such as SQQQ. Large losses require even larger rallies to get back to the starting point. This is covered in more detail by the SEC in its warnings on leveraged funds.
On top of this, other factors can weigh on performance. The fund page warns about the discrepancies possible in longer holding periods.
For any holding period other than a day, your return may be higher or lower than the Daily Target. These differences may be significant. Smaller index gains/losses and higher index volatility contribute to returns worse than the Daily Target. Larger index gains/losses and lower index volatility contribute to returns better than the Daily Target.
The more extreme these factors are, the more they occur together, and the longer your holding period while these factors apply, the more your return will tend to deviate. Investors should consider periodically monitoring their geared fund investments in light of their goals and risk tolerance.
The below table is from the prospectus and adds further information on the various conditions which can lead to deviations in return, both negative and positive.
As volatility has been low, and index moves have been high, the deviations from a simple -3x return have tended to work in SQQQ’s favor. We can see from the graphic below that it added a slight tailwind to daily returns in July so far. For example, on the 3rd July, the index returned +0.88% while SQQQ returned -2.52% instead of the expected -3x of -2.66%.
Another factor slightly boosting returns could come from the accumulated dividend, something covered in the next section.
Holdings and Dividend
SQQQ’s portfolio is made up of two parts. Firstly, it has a $-7.4B exposure to the QQQ in the form of swap agreements with major banks and an E-mini Nasdaq 100 short. The -$7.4B exposure is -3x its AUM of $2.44B.
The second part of the portfolio is made up of US Treasury Bills. SQQQ holds about $4B in Bills but has -$1.6B in liabilities, and this makes up its AUM of $2.4B. The Bills are effectively cash / collateral on the swap agreements and have the benefit of paying interest. We can assume this is around the 5.25% offered by short-term USTs.
SQQQ’s dividend yield is listed on Seeking Alpha as 12.59%, which sounds a lot better than it is. As it is a TTM figure and SQQQ has fallen -62%, the yield is more than doubled when calculated at today’s prices. In reality, the distributions have fallen and the current annualized yield of the $0.1605 pay-out is 8.6%. Distributions are likely to fall further in the coming quarters.
Needless to say, SQQQ is not an ETF to hold for a stable dividend. The added distributions are a small bonus offered by the fund’s UST holdings.
Other Considerations
SQQQ has a high expense ratio of 0.95% which is average for leveraged funds. There are high costs associated with maintaining its portfolio.
Liquidity is excellent, with an impressive Average Daily Dollar Volume of $1.2B.
Uses
As the introduction mentions, SQQQ is most suited to trading short-term swings in the QQQ. I find an ideal holding period is for several weeks, up to around 3 months. It can be held longer, but you would have to be fairly certain of a sustained correction in the QQQ, which is unusual.
Due to its erratic performance over periods of more than one day, SQQQ is difficult to hedge with accurately. It can be useful to trade alongside other long positions, but a perfect hedge on a portfolio would require daily rebalancing and software.
Holding long-term or trying to hold for the dividend is not advisable. I have written about trying to hedge a -3x ETF with its 3x cousin and hold for the distributions, but this has too much risk to really treat the trade as an income investment.
Conclusions
SQQQ is a high-risk and high reward ETF, providing -3x exposure to the Nasdaq. It is best suited to short-term swings and can deliver impressive gains if a trade is timed right. If held too long, however, you are likely to face a total loss of your position.
SQQQ has added appeal due to its distributions and slightly better than intended -3x return. Liquidity is excellent and there are no major red flags.
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