Do Leveraged and Inverse ETFs Converge to Zero? (2024)

FAQs

Do Leveraged and Inverse ETFs Converge to Zero? ›

Over the long-term, inverse ETFs with high levels of leverage, i.e., the funds that deliver three times the opposite returns, tend to converge to zero (Carver 2009 ).

What Happens If Triple Leveraged ETFs Go to Zero? Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.

For most standard, unleveraged ETFs that track an index, the maximum you can theoretically lose is the amount you invested, driving your investment value to zero. However, it's rare for broad-market ETFs to go to zero unless the entire market or sector it tracks collapses entirely.

Yes, leveraged ETFs can go negative in value. However, it's essential to understand the mechanisms behind leveraged ETFs and how they can lead to negative returns. Leveraged ETFs aim to deliver a multiple (2x or 3x) of the daily returns of an underlying index or benchmark.

Bottom Line. Leveraged ETFs decay due to the compounding effect of daily returns, volatility of the market and the cost of leverage. The volatility drag of leveraged ETFs means that losses in the ETF can be magnified over time and they are not suitable for long-term investments.

Over the long-term, inverse ETFs with high levels of leverage, i.e., the funds that deliver three times the opposite returns, tend to converge to zero (Carver 2009 ).

Leveraged ETFs amplify daily returns and can help traders generate outsized returns and hedge against potential losses. A leveraged ETF's amplified daily returns can trigger steep losses in short periods of time, and a leveraged ETF can lose most or all of its value.

Theoretically, any investment, including QQQ, can experience a decline in value and potentially become worthless. However, it is important to note that QQQ represents a basket of established companies listed on the Nasdaq Stock Market, which makes the likelihood of it going to zero highly improbable.

Several papers have established that investors who hold these investments for periods longer than a day expose themselves to substantial risk as the holding period returns will deviate from the returns to a leveraged or inverse investment in the index.

An inverse ETF is intended for intraday trading. The more frequently you trade intraday, the more transaction costs you incur. Owning an inverse ETF can result in losses if the ETF's target index rises in value — the sharper the increase, the greater the loss will be.

How long can you hold inverse leveraged ETF? ›

Investors who wish to hold inverse ETFs for periods exceeding one day must actively manage and rebalance their positions to mitigate compounding risk. The effect of compounding returns becomes more conspicuous during periods of high market turbulence.

The two major risks associated with leveraged ETFs are decay and high volatility. High volatility translates to high risk. Decay emanates from holding the ETFs for long periods.

Nearly all leveraged ETFs come with a prominent warning in their prospectus: they are not designed for long-term holding. The combination of leverage, market volatility, and an unfavorable sequence of returns can lead to disastrous outcomes.

Because they rebalance daily, leveraged ETFs usually never lose all of their value. They can, however, fall toward zero over time. If a leveraged ETF approaches zero, its manager typically liquidates its assets and pays out all remaining holders in cash.

By some estimates, returns generate up to 74% less rebalancing by leveraged and inverse ETFs once capital flows are taken into account. As a consequence, the potential for these types of products to exacerbate volatility should be much lower than many claim.

The Direxion Daily Junior Gold Miners Index Bull 3x Shares (JNUG) and the Direxion Daily Junior Gold Miners Index Bear 3x Shares (JDST) are the two most volatile exchange-traded funds of all. Each has a one-year volatility reading of about 170.

Negative leverage raises overall risk and lessens the margin for issues with operations. To avoid getting into such a situation, investors should compare the cost of debt to the property's capitalization rate.

In leverage trading, you're required to maintain a certain amount of equity (initial margin) in your account to cover potential losses. If the market moves against you and your account falls below the required margin, you will face what is referred to as margin call.

Because leveraged single-stock ETFs in particular amplify the effect of price movements of the underlying individual stocks, investors holding these funds will experience even greater volatility and risk than investors who hold the underlying stock itself.