The Rules Of The Game With Leveraged ETF’s

Share This Article
November 2, 2009 2:51pm ETF BASIC NEWS

rulesSoberLook put out an interesting piece on the rules of the game in leveraged ETF’s:  As volatility returns to the markets, it’s worth revisiting leveraged ETFs


 and the tracking error associated with these products.

The rules of the game are simple:

1. Leveraged ETFs do well relative to the underlying index in trending markets,
2. underperform in mean-reverting markets,
3. underperform significantly in mean-reverting high volatility markets,
4. underperform over longer periods of time,
5. inverse (bear) leveraged ETFs underperform more than the equivalent leverage bull ETFs. The tracking error for a bear ETF is equivalent to a bull ETF with an extra turn of leverage. That is an inverse ETF tracking error is equivalent to that of a 2x bull ETF. The error for a 2x inverse ETF is equivalent to that of a 3x bull ETF, etc.

The chart below shows a potential underperformance (in a mean-reverting market) for leveraged bull ETFs over a one-month period (roughly) as a function of daily volatility.

The chart below shows the same for inverse ETFs (bear ETFs).

Here is an example of what happens with leveraged ETFs over a longer period of time. The chart below compares TNA, a 3x Russel 2000 ETF with the performance of Russell 2000 (small cap index). The index is up some 12% YTD, while TNA instead of being up three times that is actually up less than half for the year.

So if you really like risk, by all means take advantage of all the leverage available out there (before the SEC takes some “anti-derivatives” action against these products), but keep mindful of the nasty tracking error.

VISIT SOBER LOOK: HERE

  • Get 10 Trading Lessons FREE Click Here
  • GET A FREE TREND ANALYSIS FOR ANY ETF HERE!


  • 7 Best ETFs for the NEXT Bull Market

    Read Next



    Free Investing Ideas Newsletter!

    Join over 70,000 investors who get the latest insights and top rated picks from our free investment newsletter.

    Most Popular



    9 'MUST OWN' Growth Stocks for 2021

    Explore More from ETFDailyNews.com

    Free Investment Newsletter

    Join over 70,000 investors who get the latest insights and top rated picks from our free investment newsletter.

    ETFDailyNews.com respects your privacy.

    Best ETFs

    We've rated and ranked nearly 2,000 ETFs and ETNs using our proprietary SMART Grade system.

    View Top Rated ETFs

    Best Categories

    We've ranked dozens of ETF categories based on relative performance.

    Best ETF Categories