A Comprehensive Guide to Leveraged ETF Strategy

A leveraged ETF strategy can be a powerful tool for investors looking to amplify their returns, but it's essential to understand how they work and the associated risks.

Leveraged ETFs use derivatives, such as futures and options, to magnify their returns by a set multiple, typically 1.5 or 2 times the daily performance of the underlying index.

These ETFs can be a game-changer for investors who want to make a big impact with a small amount of capital, but they can also be volatile and may not perform as expected over time.

Investors should carefully consider their risk tolerance and investment goals before using a leveraged ETF strategy, as the potential for losses is higher than with traditional investments.

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ETFs are a type of investment that holds a basket of securities, such as stocks, bonds, or commodities.

They can be non-leveraged, which means they simply track an underlying index or asset class with the goal of matching its performance.

Non-leveraged ETFs hold only shareholder equity, without any debt.

Leveraged ETFs, on the other hand, use debt to amplify daily returns to shareholders.

They aim to generate daily returns that are multiples of the performance of the underlying index or asset class.

Leveraged ETFs often use derivatives, such as options and futures contracts, to amplify returns.

Inverse leveraged ETFs use derivatives to generate the opposite of the daily return of an index or asset class.

Investors who expect the value of an index or asset class to decline may buy shares in an inverse leveraged ETF.

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Exchange-traded funds let an investor buy lots of stocks and bonds at once.

Leveraged and inverse ETFs and ETNs are unique and involve additional risks and considerations not present in traditional products.

These funds are designed to deliver their stated returns only for the length of their reset periods, which can be daily or monthly.

Investing in ETFs can be a straightforward process.

Exchange-traded funds let an investor buy lots of stocks and bonds at once. This can be a convenient way to diversify a portfolio.

By investing in ETFs, you can gain access to a broad range of assets with a single trade. This can save time and effort compared to buying individual stocks or bonds.

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Before investing in ETFs, it's essential to consider your investment style.

You need to think about how much risk you're willing to take on, and what your financial goals are.

If you're conservative, you may want to start with a low-risk ETF that tracks a broad market index.

Consider your investment horizon, or how long you can afford to keep your money invested.

If you're investing for the long-term, you can take on more risk and potentially earn higher returns.

Your investment style will also determine how often you want to buy and sell ETFs.

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Leveraged ETFs involve additional risks and considerations not present in traditional products. They're designed to double or triple the performance of a particular index over a stated period, but their rebalancing methodologies and compounding math can lead to results different from a simple doubling or tripling of the benchmark's average return.

Most leveraged and inverse ETFs reset on a daily or monthly basis, so you can expect a return similar to the stated objective on any given day. However, extended holdings beyond one day or one month can lead to results different from the stated objective.

The structure of leveraged ETFs can be particularly damaging in volatile markets that exhibit no clear trend or direction. Daily rebalancing can cause the fund to respond to gains by increasing exposure to the benchmark index, and respond to losses by decreasing exposure, which can lead to a continued pattern of decay in the fund's returns.

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A continued pattern of this sort will typically cause the decay of the longer-term returns of the fund. For example, a fund that had a negative return after a six-day period of volatile yet cumulatively flat benchmark index returns. You can follow the math to better understand how this occurs.

Direxion Daily Leveraged ETFs are a part of the Direxion Shares ETF Trust and are bought and sold in the secondary market on the NYSE ARCA, Inc., The Nasdaq Stock Market, LLC, and other exchanges.

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Leveraged and inverse ETFs can be riskier than traditional investments, with unique risks and considerations not present in traditional products. They can involve compounding math and rebalancing methodologies that can lead to results different from a simple doubling, tripling, or inverse of the benchmark's average return.

The effects of leverage are compounded over time, making long-term returns generated by these ETFs not simply mirror the returns of the index or asset class they are designed to track. In volatile markets, leveraged ETFs can severely underperform relative to the asset or index they track.

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A triple-leveraged S&P 500 ETF loses 60% when the underlying index only loses 20%, illustrating the potential for significant losses. This is because the fund must respond to losses by decreasing its exposure to the index, which reduces the impact of subsequent unfavorable index movements.

Daily market fluctuations can cause the funds' net asset levels to rise or fall, resulting in portfolio adjustments to help ensure that exposure levels are set at the correct multiple. This can lead to a continued pattern of increasing exposure in advance of a loss and decreased exposure in advance of a gain, causing the decay of the longer-term returns of the fund.

In volatile markets that exhibit no clear trend or direction, the impact of daily rebalancing can be particularly harmful to the performance of leveraged ETFs over time. This can result in a negative return after a short period, even if the benchmark index returns are flat or slightly positive.

Direxion Daily Leveraged ETFs are traded in the secondary market, and their market prices will fluctuate in response to changes in net asset value and supply and demand for the shares. On occasion, ETFs may trade at larger-than-expected premiums due to a lack of supply of outstanding shares available in the markets.

Frequent monitoring of your position is recommended, as situations can evolve rapidly, especially in volatile markets. This can help you act accordingly and manage decay risk, which starts to creep in when holding the fund beyond a couple of days or weeks.

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Counterparty risk is a real concern for investors, especially when it comes to ETFs that use financial instruments involving counterparties to gain added exposure to benchmark indexes.

Direxion Shares, for example, may invest in swaps and futures contracts with multiple brokers to minimize counterparty risk.

Counterparty risk occurs when a firm may be exposed to monetary loss if the counterparty encounters difficulty meeting its contractual obligations.

Direxion strives to minimize this risk by regularly monitoring the balance sheets of all counterparties and suspending or terminating relationships with any organization showing material signs of insolvency.

A swap is a type of derivative where two counterparties agree to exchange one stream of cash flows for another, calculated over a notional principal amount.

This notional principal amount is usually not exchanged between counterparties, which can create unfunded exposures to an underlying asset.

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Leveraged ETFs can be riskier than traditional investments, with unique risks and considerations that investors should be aware of.

Leveraged and inverse ETFs are designed to double or triple the performance of a particular index over a stated period of time, but their rebalancing methodologies and compounding math can lead to results different from a simple doubling, tripling, or inverse of the benchmark's average return.

These funds aren't generally designed for a buy-and-hold strategy, even if the "hold" period covers only several days, and are riskier than alternatives that don't use leverage.

It's crucial to actively monitor and manage your portfolio if you invest in leveraged ETFs.

Direxion Daily Leveraged ETFs can trade at larger-than-expected premiums due to a lack of supply of outstanding shares available in the markets.

The result could be that an investor may buy shares at a price that is somewhat inflated above the total market value of the underlying holdings of the fund.

The market prices of the shares will fluctuate in response to changes in net asset value (NAV) and supply and demand for the shares.

It's not possible to accurately predict whether the shares will trade above, below, or at their NAV.

The decay risk starts to creep in when holding a leveraged ETF beyond a couple of days or weeks.

Frequent monitoring of your position is recommended to act accordingly in volatile markets.

Clear targets for entry and exit points are essential before investing in a leveraged ETF.

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Direxion Daily Funds are designed to seek daily leveraged investment results, before fees and expenses, of 300% or 200% of the performance of their benchmark index for bull funds. This means they aim to provide twice or three times the return of the benchmark index in a single day.

Each Direxion Daily Leveraged ETF has a daily investment objective, which is to magnify or provide inverse exposure to the returns of their benchmarks for a single day. Returns for periods greater than a day are a product of the compounded daily leveraged returns during the period.

Direxion Daily Leveraged ETFs invest in derivatives, such as swaps or futures, to obtain the necessary exposure to their benchmark indexes. Bull Funds generate between 10% and 100% of their requisite exposure level from equities and the remainder from derivatives.

Here are some key facts about Direxion Daily Leveraged ETFs:

There is no guarantee that the funds will achieve their investment objective, as the performance of the benchmark index can be unpredictable.

Leveraged ETFs are designed to magnify the return of a benchmark, while inverse ETFs seek to have the opposite return of an index.

These funds have daily performance objectives, but over the long term, their performance can deviate widely from the stated multiple of the performance. This is because they reset over short periods, such as daily or monthly, and are designed to deliver their stated returns only for the length of their reset periods.

For example, a 2x leveraged ETF aims to double the performance of a particular index, but this doesn't mean it will double the return over a longer period. In fact, extended holdings beyond one day or one month can lead to results different from a simple doubling of the benchmark's average return over the same period.

Key points to keep in mind:

Leveraged and inverse ETFs are unique investments that involve additional risks and considerations not present in traditional products. They're designed to double or triple the performance of a particular index over a stated period of time.

These funds are often identified with a multiplier in their names, such as "2x" or "3x", or may have a fund-specific description such as "ultra." They're designed to deliver the opposite return of an index, or a multiple of the opposite return of the index.

Most leveraged and inverse ETFs reset on a daily or monthly basis and are therefore designed to deliver their stated returns for the reset period only. This means that on any given day, if you use a leveraged or inverse product, you can expect a return similar to the stated objective.

However, because of the structure of these products, their rebalancing methodologies, and the compounding math, extended holdings beyond one day or one month can lead to results different from a simple doubling, tripling, or inverse of the benchmark's average return over the same period.

Here are some key points to keep in mind:

It's essential to understand that these funds are not designed for a buy-and-hold strategy, even if the "hold" period covers only several days. They're meant to be traded in short-term windows, and frequent monitoring of your position is recommended.

Commodity and Volatility Futures are investments that are traded on an exchange, similar to individual stocks.

Their price and value may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity.

Commodity and Volatility Futures can be subject to greater volatility than securities, making them not suitable for all investors.

Unique risk factors include the use of aggressive investment techniques, such as options, futures, forwards, or other derivatives.

Correlation or inverse correlation can also impact the product's value.

Market price variance risk and leverage are other factors to consider.

These investments may not be suitable for all investors due to their high volatility and unique risk factors.

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Long-term holding of leveraged ETFs is not recommended. These funds are primarily used for short-term trading opportunities, and investors usually hold them for a day or two, or up to 10-14 days on the longer side.

The decay risk is a substantial reason for this, as the performance of these ETFs can drift away from the underlying asset over time. Time decay starts to compound and become more noticeable the longer you hold onto an asset.

In fact, the decay incurred over a year of holding a leveraged ETF is much more noticeable than what an investor would experience in a week.

These investments are for sophisticated investors comfortable with risk. They have daily performance objectives, but over the long term, their performance can deviate widely from the stated multiple of the performance.

If you're considering holding a leveraged ETF for an extended period, be aware that the risks are higher than short-term trading.

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