Leveraged ETF Basics
Leveraged (long) ETFs intend to deliver 2x or 3x the daily performance of the underlying index. Contra-ETFs (or inverse ETFs) intend to replicate 1x, 2x, or 3x the daily inverse performance of the underlying index. The leveraged feature magnifies the performance of the underlying index.
I use leveraged ETFs when I feel the market is going down because it is much easier than shorting stocks or buying Puts. To illustrate, let’s take a look at a suite of leveraged ETFs we can use in place of shorting.
- The Short S&P 500 ProShares (SH) aims to deliver the opposite daily performance of the S&P 500.
- The UltraShort S&P 500 ProShares (SDS) aims to deliver twice the opposite daily performance of the S&P 500
- The Direxion Large Cap Bear 3x Shares (BGZ) aims to deliver triple the opposite daily performance.
A 1% loss in the S&P 500 would (ideally) translate into a 1% gain for SH, a 2% gain for SDS, and a 3% gain for BGZ.
As you see above, BGZ offers the opportunity for the largest gains when the markets move down. If you are more conservative and want to take less risk, you could switch from BGZ to SDS or SH.
These are a few of the inverse ETFs for the S&P 500. The other indices have ETFs to replicate their return also.
For a list of the most popular leveraged ETF’s, check out the ETF Database.
Many oppose the use of leveraged ETF’s because they can magnify a loss pretty quickly. The solution is to just use an 8% stop loss and that will be the worse damage you will suffer.
One of the major benefits of a leveraged ETF is that the positions of the ETF are closed out daily. This allows you to compound your returns DAILY instead of YEARLY!
We all know the secret to wealth fast is compounding. The more compounding periods you have the better. Let’s take a real life example.
From April 15 of 2016 until May 15, 2018 the S&P 500 rose 30%. Using a 3x leveraged ETF like UPRO should go up 3 x 30 = 90%. Because of these ETF’s daily compounding, UPRO went up 115%. That’s over 25% more gain in just two years.
I hope this gives a little more insight into leveraged ETF’s. If you would like to discover more ways to profit from leveraged ETFs, I highly suggest you read this article on how to do market timing where I trade leveraged ETF’s exclusively.