| This content is presented by: |  |
Leveraged ETFs
Exchange-Traded Funds, commonly known as ETFs, hold an underlying basket of securities that investors can purchase and sell without having to own each of the underlying assets.
Many ETFs are designed to serve as lower risk, long-term, passive investments. However, there are a few special types of ETFs that do not fit this mold. One of these exceptions is the Leveraged ETF, an investment vehicle with higher inherent investment risk due to the price volatility caused by the leverage utilized by the ETF. Leveraged ETFs are securities designed to be monitored daily and held for a limited period of time.
What is a Leveraged ETF?
Chapter 2 – Understanding Leveraged and Inverse ETF from Direxion on Vimeo.
A Leveraged ETF seeks to multiply the performance of an index, for example, by holding double or triple the exposure to the securities in the index it is tracking. This means that for every dollar you invest, you will receive a multiple return or loss (before fees and expenses) based on the leverage multiple of the ETF
For example, let’s say you invest $100 in an S&P 500 3x Bull Leveraged ETF. If the S&P is up 1% at the end of the day, you’ll now have ~$103. If the S&P is down 1% at the end of the day, you’ll now have ~$97. Investments held for a period longer than one day will be affected by compounding and may have an effective investment multiple which is more or less than the daily multiple of the ETF. More about compounding below.
Why is it risky to hold a leveraged ETF for more than a day?
Chapter 3 – Daily Rebalancing from Direxion on Vimeo.
Leveraged ETFs allow sophisticated investors to bet on extremely short-term shifts in the market. Most ETFs buy and sell securities in their basket to reflect the index they track, generally quarterly (Please read the ETFs prospectus as this can vary by ETF), a practice called rebalancing.
However, leveraged ETFs also have a daily rebalance function. The daily rebalance is designed to reset the exposure of the ETF to align with the ETFs investment mandate. For example, if you purchased a 3X Bull ETF, and at the end of the trading day the ETF had increased in value, then the portfolio manager must purchase additional exposure to rebalance the leveraged multiple of the ETF prior to the next trading day.
Because of the multiplier on the return and the daily rebalancing, holding leveraged ETFs for any longer than a day exposes your portfolio to investment leverage which may be more or less than the daily leverage of the ETF which could lead to higher daily investment gains or losses. This is called compounding risk.
During periods of significant market volatility, an investor risks losing the full principal value of their investment within a single day should the underlying index move more than 50% (2x ETFs) or 33% (3x ETFs). Similarly, during such scenarios, leveraged ETFs may not be able to provide the leveraged exposure sought per prospectus.
Let’s compare what would happen if you invested $100 in an S&P 500 ETF and a 3x Leveraged S&P 500 ETF in different market conditions.
Rising Market:
| Day | S&P 500 Price | S&P 500 Return | S&P 500 3x Return | S&P ETF Investment | 3x Leveraged S&P ETF Investment |
| 0 | 5,000.00 | – | – | $100.00 | $100.00 |
| 1 | 5,050.00 | 1.00% | 3.00% | $101.00 | $103.00 |
| 2 | 5,151.00 | 2.00% | 6.00% | $103.02 | $109.18 |
| 3 | 5,202.51 | 1.00% | 3.00% | $104.05 | $112.46 |
| 4 | 5,358.59 | 3.00% | 9.00% | $107.17 | $122.58 |
| 5 | 5,492.55 | 2.50% | 7.50% | $109.85 | $131.77 |
| Total Return | 492.55 | 9.85% | 31.77% | $9.85 | $31.77 |
Over the course of 5 days, the leveraged investment gained more than 3x the return of the non-leveraged investment.
Falling Market:
| Day | S&P 500 Price | S&P 500 Return | S&P 500 3x Return | S&P ETF Investment | 3x Leveraged S&P ETF Investment |
| 0 | 5,000.00 | – | – | $100.00 | $100.00 |
| 1 | 4,950.00 | -1.00% | -3.00% | $99.00 | $97.00 |
| 2 | 4,851.00 | -2.00% | -6.00% | $97.02 | $91.18 |
| 3 | 4,802.49 | -1.00% | -3.00% | $96.05 | $88.44 |
| 4 | 4,658.42 | -3.00% | -9.00% | $93.17 | $80.48 |
| 5 | 4,541.95 | -2.50% | -7.50% | $90.84 | $74.45 |
| Total Return | -458.05 | -9.16% | -25.55% | -$9.16 | -$25.55 |
Over the course of 5 days, the leveraged investment lost $25.55 – about 2.8x the loss of the non-leveraged investment.
Volatile Market:
| Day | S&P 500 Price | S&P 500 Return | S&P 500 3x Return | S&P ETF Investment | 3x Leveraged S&P ETF Investment |
| 0 | 5,000.00 | – | – | $100.00 | $100.00 |
| 1 | 5,500.00 | 10.00% | 30.00% | $110.00 | $130.00 |
| 2 | 5,000.00 | -9.09% | -27.27% | $100.00 | $94.55 |
| 3 | 4,500.00 | -10.00% | -30.00% | $90.00 | $66.18 |
| 4 | 4,750.00 | 5.56% | 16.67% | $95.00 | $77.21 |
| 5 | 5,000.00 | 5.26% | 15.79% | $100.00 | $89.40 |
| Total Return | 0.00 | 0.00% | -10.60% | $0.00 | -$10.60 |
Over the course of 5 days, the leveraged investment lost $10.60 while the non-leveraged investment remained flat.
Note: The information above represents hypothetical illustration that is intended to demonstrate compounding with leveraged ETFs. It does not represent actual an actual investment, and is not investment advice, nor a forecast or guarantee of future results. Illustrations of hypothetical principles have inherent limitations and cannot account for future economic conditions.
How do investors determine the role of leveraged ETFs in their strategies?
Leveraged ETFs come with the potential for outsized gains—or losses—and require a more hands-on, short-term approach that may diverge from a typical long-term investing strategy. Sophisticated investors will sometimes combine long- and short-term approaches; however, it’s important to understand the full context before trading leveraged products.
Ask yourself the following questions:
- Are you a sophisticated, experienced investor?
- Do you understand how leveraged ETFs work, and how compound risk could impact performance?
- Do you understand and accept the potential to lose substantial amounts in short periods of time?
- Are you able to actively monitor and manage your leveraged ETF investments throughout the day by buying and selling shares?
If you can answer yes to all of the questions above, trading leveraged ETFs may be suitable for you.
Inverse ETFs
Exchange-Traded Funds, commonly known as ETFs, hold an underlying basket of securities that investors can purchase and sell without having to own each of the underlying assets.
Many ETFs are designed to serve as lower risk, long-term, passive investments. However, there are a few special types of ETFs that do not fit this mold. One of these exceptions is the inverse and inverse Leveraged ETF, an investment vehicle with higher inherent investment risk due to the price volatility caused by the leverage utilized by the ETF. Leveraged ETFs are securities designed to be monitored daily and held for limited periods of time.
What are inverse ETFs?
While many ETFs track the results of an index, inverse ETFs track the opposite results of an index.
Inverse ETFs can be used to bet against the market. For example, if an investor thinks that the market is going to decline, he or she can purchase an inverse ETF to benefit from the dip, or to hedge against potential losses in the rest of his or her portfolio.
For example, let’s say you invest $100 in an S&P 500 Inverse ETF. If the S&P is up 1% at the end of the day, you’ll now have ~$99. If the S&P is down 1% at the end of the day, you’ll now have ~$101. . Investments held for a period longer than one day will be affected by compounding and may have an effective investment multiple which is more or less than the daily multiple of the ETF. More about compounding below.
Why is it risky to hold an inverse ETF for more than a day?
Inverse ETFs allow sophisticated investors to bet on extremely short-term shifts in the market. Most ETFs buy and sell securities in their basket to reflect the index they track quarterly, a practice called rebalancing. However, inverse ETFs also have a daily rebalance. The daily rebalance is designed to reset the exposure of the ETF to align with the ETFs investment mandate. For example, if you purchased a 3X Bear ETF, and at the end of the trading day the ETF has decreased in value, then the portfolio management must purchase additional exposure to rebalance the leveraged multiple of the portfolio prior to the next trading day.
Because of the inverse multiplier on the return and the daily rebalancing, holding them for any longer than a day exposes your portfolio to investment leverage which may be more or less than the daily leverage of the ETF which could lead to higher daily investment gains or losses. This is called compounding risk.
Let’s compare what would happen if you invested $100 in an S&P 500 ETF and an Inverse S&P 500 ETF in different market conditions.
Rising Market:
| Day | S&P 500 Price | S&P 500 Return | Inverse S&P 500 Return | S&P ETF Investment | Inverse S&P ETF Investment |
| 0 | 5,000.00 | – | – | $100.00 | $100.00 |
| 1 | 5,050.00 | 1.00% | -1.00% | $101.00 | $99.00 |
| 2 | 5,151.00 | 2.00% | -2.00% | $103.02 | $97.02 |
| 3 | 5,202.51 | 1.00% | -1.00% | $104.05 | $96.05 |
| 4 | 5,358.59 | 3.00% | -3.00% | $107.17 | $93.17 |
| 5 | 5,492.55 | 2.50% | -2.50% | $109.85 | $90.84 |
| Total Return | 492.55 | 9.85% | -9.16% | $9.85 | -$9.16 |
Over the course of 5 days, the inverse investment lost less than 1x the return of the non-inverse investment.
Falling Market:
| Day | S&P 500 Price | S&P 500 Return | Inverse S&P 500 Return | S&P ETF Investment | Inverse S&P ETF Investment |
| 0 | 5,000.00 | – | – | $100.00 | $100.00 |
| 1 | 4,950.00 | -1.00% | 1.00% | $99.00 | $101.00 |
| 2 | 4,851.00 | -2.00% | 2.00% | $97.02 | $103.02 |
| 3 | 4,802.49 | -1.00% | 1.00% | $96.05 | $104.05 |
| 4 | 4,658.42 | -3.00% | 3.00% | $93.17 | $107.17 |
| 5 | 4,541.95 | -2.50% | 2.50% | $90.84 | $109.85 |
| Total Return | -458.05 | -9.16% | 9.85% | -$9.16 | $9.85 |
Over the course of 5 days, the inverse investment gained more than 1x the return of the non-inverse investment.
Volatile Market:
| Day | S&P 500 Price | S&P 500 Return | Inverse S&P 500 Return | S&P ETF Investment | Inverse S&P ETF Investment |
| 0 | 5,000.00 | – | – | $100.00 | $100.00 |
| 1 | 5,500.00 | 10.00% | -10.00% | $110.00 | $90.00 |
| 2 | 5,000.00 | -9.09% | 9.09% | $100.00 | $98.18 |
| 3 | 4,500.00 | -10.00% | 10.00% | $90.00 | $108.00 |
| 4 | 4,750.00 | 5.56% | -5.56% | $95.00 | $102.00 |
| 5 | 5,000.00 | 5.26% | -5.26% | $100.00 | $96.63 |
| Total Return | 0.00 | 0.00% | -3.37% | $0.00 | -$3.37 |
Over the course of 5 days, the non-inverse investment remained flat while the inverse investment lost 3.37%.
Note: The information above represents hypothetical illustration that is intended to demonstrate compounding with leveraged ETFs. It does not represent actual an actual investment, and is not investment advice, nor a forecast or guarantee of future results. Illustrations of hypothetical principles have inherent limitations and cannot account for future economic conditions.
How do investors determine the role of inverse ETFs in their strategies?
Inverse ETFs come with the potential for outsized gains—or losses—and require a more hands-on, short-term approach that may diverge from a typical long-term investing strategy. Sophisticated investors will sometimes combine long- and short-term approaches; however, it’s important to understand the full context before trading higher-risk products.
Ask yourself the following questions:
- Are you a sophisticated, experienced investor?
- Do you understand how leveraged ETFs work, and how compound risk could impact performance?
- Do you understand and accept the potential to lose substantial amounts in short periods of time?
- Are you able to actively monitor and manage your leveraged ETF investments throughout the day by buying and selling shares?
If you can answer yes to all of the questions above, trading inverse ETFs may be suitable for you.
Disclosures: An investor should carefully consider a Fund’s investment objective, risks, charges, and expenses before investing. A Fund’s prospectus and summary prospectus contain this and other information about the Direxion Shares. To obtain a Fund’s prospectus and summary prospectus call 866-476-7523 or visit our website at www.direxion.com. A Fund’s prospectus and summary prospectus should be read carefully before investing.
Distributor: Foreside Fund Services, LLC.