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From Theory to Practice

Degrees of Drag

Aug 29, 2016

The drag that exists in certain products can come from two different sources. First, there is the usual type of drag that applies to any product that is priced off of the futures market. When the futures are in contango, the resulting relationship between the spot price/futures price creates downward pressure on that futures price. As a result, this product will tend to drift lower due to this drag. Second, there is another type of drag that results from the volatility tax that we recently learned about with leveraged ETFs. As these funds reset their reference points each day, the very nature of leveraged returns imposes a drag on their returns. Furthermore, any additional volatility will only serve to exacerbate this drag.

With more than one source of drag in the marketplace, different products could be exposed to various degrees of drag. In this segment, we explore exactly what this looks like for different volatility products.

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