Exchange-traded funds, or ETFs, are popular methods of investing in the stock market. They are composed of a basket of assets and provide some much-needed diversification to a portfolio.
However, ETFs can vary greatly in their composition and volatility, which is why it is important to carefully consider multiple options before putting your capital at risk.
Some ETFs come with leverage and allow traders to get considerably higher returns than they would by simply buying shares in one of the hundreds of ETFs available on the stock market.
While leveraged ETFs may be more promising and could deliver greater returns, they are also considerably more risky than standard actively managed ETFs and index funds.
Regardless, if you are a trader with a higher-than-average risk tolerance, leveraged ETFs could come in handy during bull runs in specific sectors and markets.
What Are Leveraged ETFs And How Do They Work?
Leveraged ETFs are a subset of exchange-traded funds that aim to deliver amplified returns by using various financial instruments on a benchmark index. They use derivatives and debt to magnify the daily performance of the underlying index.
Leveraged ETFs are designed for short-term trading and are generally not suited for long-term investment.
Here’s how a leveraged ETF generally works:
A typical leveraged ETF might aim to provide 2x or 3x the daily return of the underlying index. For example, if the underlying index gains 1% in a day, a 2x leveraged ETF might aim to generate a return of 2%
Leveraged ETFs use financial derivatives, such as options, futures, and swaps to achieve the desired leveraged exposure. These derivatives allow the ETF to take on additional risk in pursuit of higher returns
At the end of each trading day, the ETF resets its exposure to the specified leverage ratio, which may involve buying or selling derivatives and assets to maintain the desired amplification. This means that leveraged ETFs are actively managed and require daily rebalancing to stay on track
The daily rebalancing process can lead to a compounding effect that may result in returns deviating from the expected multiple over longer holding periods. As a result, the actual long-term returns of the leveraged ETF may not exactly match the multiple of the underlying index’s returns
6 Leveraged ETFs To Consider Trading
The best-leveraged ETFs are characterized by a high trading volume, which gives traders much-needed liquidity, a minimum of 2X leverage for higher returns, and a reliable underlying index that is relatively easy to track and gather data on,
ProShares and Direxon are two of the most popular ETF issuers, with funds tracking a wide number of important benchmark indexes across all major sectors of the economy.
ProShares UltraPro QQQ (TQQQ)
The ProShares UltraPro QQQ is an ETF that tracks the performance of the Nasdaq-100, which is one of the most important and widely followed indexes of the U.S. stock market.
TQQQ’s 3X leverage aims to deliver three times the returns of the underlying index.
The fund is designed for traders with a short-term bullish outlook on large-cap Nasdaq stocks, such as Apple, Microsoft, Alphabet, etc.
The fund invests exclusively in derivative contracts and does not hold any equity in its portfolio. The average 3-month trading volume for TQQQ shares is 137.4 million.
TQQQ has an expense ratio of 0.86% and was launched on February 9, 2010.
The ProShares UltraPro QQQ ETF has returned more than 20% over the past 12 months of trading.
ProShares UltraPro Short QQQ (SQQQ)
The ProShares UltraPro Short QQQ is another ETF that tracks the Nasdaq-100 index and seeks to deliver inverse returns. When the Nasdaq-100 goes up, SQQQ goes down by three times as much, as the ETF has a 3X short leverage.
SQQQ is designed for traders with a short-term bearish sentiment on large-cap Nasdaq stocks.
The expense ratio of SQQQ is 0.95%, with an average 3-month trading volume of 130.1 million shares.
SQQQ was also launched on February 9, 2010.
SQQQ has lost over 50% of its value over the past 12 months, while the Nasdaq-100 has gained 16% over the same period.
ProShares UltraPro S&P 500 ETF (UPRO)
The ProShares UltraPro S&P 500 ETF, or UPRO, is a more stable ETF that tracks the performance of the main stock market benchmark in the United States - the S&P 500.
The fund was launched on June 25, 2009, with a 3X leverage and an expense ratio of 0.91%.
The average 3-month trading volume for UPRO is 9.4 million shares.
The fund was developed for traders that have a bullish stance on the S&P 500. However, UPRO is also viable as a long-term investment, as the fund tracks one of the most stable and liquid indexes in the world.
UPRO has underperformed the S&P 500 over the past 12 months. The fund has returned 5.85%, while the S&P 500 has returned 8.15% over the same period.
This is due to the 3X leverage of UPRO, which means that the downturns of the fund are also amplified threefold.
Direxion Daily Small Cap Bull 3X ETF (TNA)
The Direxion Daily Small Cap Bull 3X ETF, or TNA, is a highly volatile leveraged ETF with a focus on small-cap stocks primarily listed on the NYSE.
The fund, which was launched on November 5, 2008, has an expense ratio of 1.09%.
Due to the focus on small-cap stocks and 3X leverage, TNA can be a highly volatile ETF, which makes it attractive for short-term traders who wish to profit off of short-term trend reversals on the equities market.
The fund has an average 3-month trading volume of 13.2 million shares.
TNA has lost roughly 22% over the past year. However, with many ups and downs during that period, the fund has shown to be very attractive for short-term traders.
Direxion Daily Tech Bull 3X ETF (TECL)
Direxion Daily Tech Bull 3X ETF is another short-term bullish leveraged technology ETF by Direxion, which tracks the Technology Select Sector ETF.
The fund’s 3X leverage makes it ideal for short-term tech bulls and makes TECL a highly volatile ETF.
TECL, which was launched on December 17, 2008, has an expense ratio of 0.97% and a 3-month daily average trading volume of 2.5 million shares.
TECL has returned over 18.5% over the past 12 months, which makes it a market-beating ETF for that period.
Direxion Daily S&P 500 Bull 3X ETF (SPXL)
The Direxion Daily S&P 500 Bull 3X also tracks the S&P 500 and aims to deliver 3X returns. The fund is highly volatile and ideal for short-term bullish traders.
SPXL was launched on November 5, 2008, and has an expense ratio of 1%, with a 3-month average daily trading volume of 12.9 million shares.
SPXL has returned 6% over the past 12 months, which is in line with the returns of the S&P 500 over the same period.
Pros & Cons Of Leveraged ETFs
Before risking your hard-earned money, it is crucial to consider the inherent advantages and risks associated with trading leveraged ETFs to avoid any costly uninformed decisions.
Pros
Leveraged ETFs have the potential to deliver amplified returns, which is denoted as a multiple in the name of the ETF. For aggressive traders who correctly time their trades, leveraged ETFs can lead to significant gains
Some leveraged ETFs are designed to deliver inverse returns as the target index, which is advantageous to traders as it allows them to profit from the downside
Leveraged ETFs offer diversification across multiple assets, industries, or sectors, making it easier for traders to gain exposure to broader market movements without holding individual stocks or assets
Traders do not have to go through the hassle of trading derivatives themselves and can gain leverage by simply buying shares in a leveraged ETF
Cons
Leveraged ETFs are inherently riskier than standard ETFs, as the use of derivatives amplifies gains, as well as losses
Due to daily rebalancing, leveraged ETFs' performance may deviate significantly from the expected multiple of the underlying index over time. This compounding effect can lead to tracking errors and unexpected outcomes, especially during volatile periods
Leveraged ETFs are designed to be short-term instruments and can be highly risky as long-term investments
Leveraged ETFs tend to have higher expense ratios compared to traditional ETFs due to the complexities involved in managing their leverage and derivatives
Market timing becomes crucial when trading leveraged ETFs, and predicting short-term market movements is challenging. A mistimed trade can lead to substantial losses
Some leveraged ETFs can be considerably less liquid than other, larger ETFs, which can limit traders
Key Takeaways From What Are Leveraged ETFs And Which Ones Should You Consider For Trading
Leveraged ETFs are exchange-traded funds that use derivatives to amplify their returns from the underlying index
Leveraged ETFs are highly risky and volatile, due to the use of derivatives, which amplifies the effect of gains and losses alike
ProShares and Direxion leveraged ETFs are highly liquid leveraged ETFs that track major indices, such as the Nasdaq-100 and the S&P 500
Leveraged ETFs typically have higher expense ratios, due to the need for daily rebalancing and active management, and monitoring
Most leveraged ETFs are structured as short-term trading instruments and are not viable as long-term investments
Let's practice!
Our partner, XM, lets you access a free demo account to apply your knowledge.
Leveraged ETFs are exchange-traded funds that use financial derivatives to amplify the returns of the underlying index. Leveraged ETFs can have higher expense ratios due to daily rebalancing and are generally more volatile than standard ETFs.
How much leverage do ETFs have?
Most leveraged ETFs aim to deliver 2X or 3X returns by using swaps, futures, and options on the underlying index. The higher the leverage, the riskier the ETF becomes.
Are leveraged ETFs risky?
Leveraged ETFs are generally riskier than standard ETFs because they use derivatives, which amplify the potential gains and losses.
