Leveraged ETF | Overview, Benefits & Risk - Lesson | Study.com (2024)

FAQs

What are the 3 advantages of leveraged ETFs? ›

In other words, you could potentially be liable for more than you invested because you bought the position on leverage. But can a leveraged ETF go negative? No. If you own a leveraged ETF you can't lose more than your initial investment amount.

Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.

Leveraged ETFs are exchange-traded funds that use derivatives and debt instruments to magnify the returns of a benchmark or index. Leveraged ETFs can generate returns very quickly, but they are also very risky.

Positive aspects of ETFs

The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.

Leveraged ETFs decay due to the compounding effect of daily returns, volatility of the market and the cost of leverage. The volatility drag of leveraged ETFs means that losses in the ETF can be magnified over time and they are not suitable for long-term investments.

Several papers have established that investors who hold these investments for periods longer than a day expose themselves to substantial risk as the holding period returns will deviate from the returns to a leveraged or inverse investment in the index.

In leverage trading, you're required to maintain a certain amount of equity (initial margin) in your account to cover potential losses. If the market moves against you and your account falls below the required margin, you will face what is referred to as margin call.

The leverage is determined on a daily basis and the returns for any other period usually will not be double or triple the underlying index. In order for the leveraged funds to achieve appropriate levels of assets so they can provide their implied leverage, they have to rebalance daily.

BMO has launched the first quadruple leveraged ETN fund that tracks the S&P 500. The fund will trade under the ticker symbol "XXXX" and seeks to generate four time the S&P 500's return on a daily basis. The launch come as bullishness rise among investors and Wall Street predicts more gains to come in 2024.

Can Tqqq fail? ›

The triple leverage can significantly magnify losses, making TQQQ a high-risk, high-reward option. The compounding of daily returns can also lead to tracking error, causing its performance to deviate from three times the index's returns over time.

The Direxion Daily Junior Gold Miners Index Bull 3x Shares (JNUG) and the Direxion Daily Junior Gold Miners Index Bear 3x Shares (JDST) are the two most volatile exchange-traded funds of all. Each has a one-year volatility reading of about 170.

ProShares UltraPro QQQ is the most popular and liquid ETF in the leveraged space, with AUM of $21.9 billion and an average daily volume of 67.3 million shares a day. The fund seeks to deliver three times the return of the daily performance of the NASDAQ-100 Index, charging investors 0.88% in annual fees.

A three-fund portfolio is a portfolio which uses only basic asset classes — usually a domestic stock "total market" index fund, an international stock "total market" index fund and a bond "total market" index fund.

Advantages and Disadvantages of Financial Leverage

Using leverage also allows you to access more expensive investment options that you wouldn't otherwise have access to with a small amount of upfront capital. Leverage is best used in short-term, low-risk situations where high degrees of capital are needed.

The rewards of leverage

Leverage increases the return on equity, improving investors' return on capital invested; investors have fewer funds at risk and their ownership percentages do not get diluted (debt financing does not reduce their control of the entity or profit allocation).