Understanding Leveraged Spy ETFs

Leveraged Spy ETFs can be a powerful tool for investors, but they're not for the faint of heart. They aim to deliver a return that's a multiple of the daily performance of the S&P 500 index, which the SPY tracks.

The most common leveraged ETFs are 2x and 3x, meaning they aim to deliver twice or three times the daily return of the S&P 500. These ETFs use financial derivatives to amplify their returns, but they also amplify their risks.

Investors should be aware that leveraged ETFs are designed to be used for short-term trading, not long-term investing. They can be volatile and may not perform as expected over time.

Inverse ETFs are designed to profit when the price of a benchmark falls. They often use futures contracts, swaps, or other derivatives to try to meet the daily return objectives.

Inverse ETFs can offer short-term portfolio hedges against declines, and are easier to use than creating a margin account for short selling. This makes them a popular choice for investors who want to protect their portfolios from market downturns.

Some examples of inverse ETFs include ProShares UltraShort Euro (EUO), a two-times leveraged inverse ETF, and DB Gold Double Short Exchange Traded Notes (DZZ), a two-times leveraged inverse ETN.

Inverse ETFs are a type of investment that seeks to profit when the price of a benchmark falls. They often use futures contracts, swaps, or other derivatives to try to meet the daily return objectives.

These ETFs are sometimes called short ETFs and are designed to offer short-term portfolio hedges against declines. They can be easier to use than creating a margin account for short selling.

Inverse ETFs are not meant to be long-term investments, but rather a way to speculate on market movements. They can offer a way to profit from a decline in the market, but they can also be highly speculative.

A good example of an inverse ETF is ProShares UltraShort Euro (EUO), a two-times leveraged inverse ETF. This ETF seeks to profit when the euro falls in value.

Here are some examples of inverse ETFs in different sectors:

Leverage is a concept that can be a bit tricky to understand, but essentially it means using borrowed money or other financial instruments to amplify your investment returns.

The idea is that if an underlying index is up 5% for a month, a double-leveraged ETF will not be up 10% for the same month, as many uninformed investors might assume.

Leveraged ETFs need to rebalance daily to achieve their implied leverage, which means they have to adjust their exposure to assets on a daily basis.

In the case of a long 2-times leveraged ETF, this means they would typically take in 100 units of assets and do a swap with a counterparty to provide exposure to 200 units in performing assets.

This rebalancing activity will almost always be in the same direction as the market, and the fund starts with a clean slate every day, as if the previous day had not existed.

As a result, a leveraged ETF is essentially marked to market every night, which can lead to daily leverage results that may not be consistent with the underlying benchmark.

Inverse ETFs are a type of investment that allows you to profit from a market decline. They do the opposite of traditional ETFs, which go up when the market goes up.

To use inverse ETFs, you need to understand that they are designed to provide a daily return that is the inverse of the daily return of the underlying index. For example, if the S&P 500 index falls by 1%, an inverse ETF tracking the S&P 500 might rise by 1%.

Inverse ETFs can be used to hedge against a potential market downturn or to speculate on a market decline. However, keep in mind that they can be volatile and may not perform as expected over longer periods of time.

A common example of an inverse ETF is the ProShares Short S&P 500 ETF (SH), which is designed to provide the opposite return of the S&P 500 index.

Leveraged ETFs seek to magnify the return of a benchmark, while an inverse ETF seeks to have the opposite return of an index. These ETFs have daily performance objectives; over the long term, their performance can deviate widely from the stated multiple of the performance.

Leveraged ETFs are designed for sophisticated investors comfortable with risk. In fact, Direxion explicitly warns that its funds are for "short-term trading" and not for long-term investments.

Here are some key differences between leveraged ETFs:

ProShares UltraPro S&P500 (UPRO) is an example of a leveraged ETF that seeks three times the daily performance of the S&P 500.

In general, ETFs are investments whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. Unlike traditional mutual funds, ETF prices change throughout the day, similar to stocks.

These investments are for sophisticated investors comfortable with risk, as they can entail market, sector, or industry risks similar to direct stock ownership. This is why brokerages typically require customers to sign a special disclaimer in order to open a margin account.

Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track. Inverse ETFs, also called "short" funds, seek to deliver the opposite of the performance of the index or benchmark they track.

Here are some examples of ETFs and their goals:

Over long periods of time, the performance of leveraged ETFs can deviate widely from the stated multiple of the performance. This is why ProShares says "Investors should monitor their holdings consistent with their strategies, as frequently as daily."

"Differ in Amount" is a crucial concept to understand when it comes to leveraged ETFs. A 2X fund might not deliver twice the return of the index.

The ProShares Ultra S&P 500 ETF, SSO, started in June 2007. $10,000 invested in the Vanguard 500 Index fund would have gained a total of $6,966 in total return since that time.

The 2X ETF, on the other hand, earned $6,097, which is less than the Vanguard 500 Index fund earnings. This shows that the 2X fund did not deliver twice the return of the index.

In fact, the 2X ETF earned less than a straight, unleveraged, direct investment in the Vanguard 500 Index fund.

Leveraged ETFs like the SPY can be a double-edged sword. They offer the potential for significant returns, but they also come with increased volatility and risk.

In a rising market, a double-leveraged ETF can outperform its expected goals and deliver returns much greater than twice the index return, due to daily compounding.

However, this increased volatility can lead to dizzying drawdowns, making it difficult for even the steeliest investors to cope. The standard deviation of monthly returns for a 3x leveraged ETF is around 38.4%, compared to 12.5% for a regular S&P 500 passive index fund.

Here's a comparison of the standard deviation of monthly returns for different ETFs between 2010 and 2019:

In the long run, the return premium for leveraged ETFs seems to disappear, while the risk remains very acute.

Leveraged ETFs can be a double-edged sword. They offer the potential for strong returns, but also come with increased volatility and risk.

In a trending market, leveraged ETFs can achieve returns much greater than twice the index return due to daily compounding. A double-leveraged ETF, for example, can grow at a faster pace as the value of the index increases.

However, this increased volatility can be daunting, even for the most seasoned investors. Between 2010 and 2019, the standard deviation of monthly returns for a 2x leveraged S&P 500 ETF was 25.3%, compared to 12.5% for a regular S&P 500 passive index fund.

Over longer periods of time, the return premium for leveraged ETFs disappears on average, while the risk remains very acute. A historical simulation showed that the annualized returns for 2x and 3x leveraged S&P 500 ETFs were 23.6% and 32.8% respectively between 2010 and 2019, but this was during a long bull market.

This means that, over the long term, the risks of leveraged ETFs may not be worth the potential rewards. It's essential to carefully consider the potential risks and rewards before investing in these types of funds.

Historical drawdowns can be particularly brutal, especially for leveraged funds. A simulation of a regular index fund, a 2x leverage fund, and a 3x leverage fund tracking the S&P 500 index from 1955 to 2019 shows just how severe the impact can be.

The oil crisis in the 1970s would have been magnified with dizzying drops and drawdowns lasting more than a decade. Drawdowns of this magnitude can be extremely challenging to recover from.

The recent Internet and financial crises would have led to nearly two decades of misery, followed by a steep recovery. This highlights the importance of having a long-term investment strategy in place.

Staying the course during such a crisis would have been extremely challenging, but it's also a testament to the power of long-term investing.

Commodity and Volatility Futures can be a wild ride, and it's essential to understand the risks involved. Commodity and volatility futures-linked ETFs and ETNs are investments that trade on an exchange, just like individual stocks.

The price and value of these products can be affected by various factors, including overall market movements, commodity index volatility, and changes in interest rates. This means that their value can fluctuate rapidly.

Commodity and volatility futures-linked ETPs may be subject to greater volatility than securities ETPs, making them unsuitable for all investors. Unique risk factors include the use of aggressive investment techniques, such as options, futures, and derivatives.

The performance of commodity-linked products can deviate significantly from the actual referenced commodity due to the use of futures or derivative products. This is because many products don't physically hold commodities.

A futures contract is an agreement to buy or sell at a certain date for a predetermined price, which generally moves along with spot prices of the commodity or index. However, this correlation is imperfect.

The "roll" process, where contracts nearing expiration are sold and proceeds used to purchase longer-dated futures contracts, can sometimes be more expensive than buying and holding the underlying commodity. This situation is known as "contango."