Leveraged Exchange Traded Funds


Leveraged Exchange Traded Funds

Leveraged ETFs

Leveraged ETFs seek to return some multiple of an index. For example, ticker SSO targets a return which is 2 times (2X) the return on the S&P 500.

  • So the leveraged ETF is similar to buying an index on margin.

  • There are also inverse leveraged ETFs. These seek to return some negative multiple of an index.

Leveraged ETF Quotes

On the next slide you can see a quote for an ETF and a leveraged ETF on the same index.

  • The quote shows the daily percent return. Note that the leveraged ETF does a fairly good job of returning a multiple of the index over a single day.

  • The ETF is the top quote, and the 2X leveraged ETF is below.

When Do Leveraged ETFs Not Work?

Leveraged ETFs do a good job of returning a multiple of an index’s return over a single day.

  • However, over any time period longer than a day, returns from the leveraged ETF will depart from being a simple multiple of the index.

  • Also, the longer you hold the Leveraged ETF, the more its returns will diverge from being a multiple of the underlying index.

Why is the Error Greater Over Longer Holding Periods?

Say both an ETF on an index and a leveraged ETF are trading for $100. The index declines by 2% today, so the ETF declines to $98 and the leveraged ETF declines to $96. Now say tomorrow the index increases by 3%, so the ETF increases to $100.94 and the leveraged ETF increases to $99.64.

  • The ETF has a two-day return of 0.94%, and the leveraged ETF returned -0.36%.

  • This is caused by the nature of returns and is not a fault in the way leveraged ETFs are managed.

Interactive App

You can use the app on the following slide to see the divergence in the return of an ETF and leveraged ETF on an index.

  • The ETF returns are multiplied by 2, because each leveraged ETF is a 2X.

  • Change the length of time to see how this affects the divergence.

List of Selected ETFs, Leveraged ETFs, and their Indices

  • S&P 500: SPY and SSO (2X)
  • Russell 2000: IWM and UWM (2X)
  • Russell 1000: IWM and TNA (3X)
  • NASDAQ 100: QQQ and QLD (2X)
  • Dow Jones Industrial Average: DIA and DDM (2X)
  • Barclay’s 7-10 yr. Treasury: IEF and UST (2X)
  • Silver (the metal): SLV and ACQ (2X)
  • U.S. Energy Sector: XLE and ERX (3X)

Credits and Collaboration

Click the following links to see the codeline-by-line contributions to this presentation, and all the collaborators who have contributed to 5-Minute Finance via GitHub.

Learn more about how to contribute here.