Investors looking at the recent election week rally might be salivating, with eyes on bigger returns. Leveraged exchange-traded funds (ETFs) could be on their radar, but they need to understand the risks before they look to the rewards.
“These ETFs promise to amplify the returns of an underlying index using debt, equity swaps and financial derivatives to create leverage,” a CNBC article explained. “Leveraging is an investing strategy that uses borrowed funds to purchase options and futures in order to increase the impact of price movements. It is a very complicated process. And if gains can be amplified — so can losses.”
“Another problem: leveraged ETFs only seek results that are leveraged to their benchmark for a single day,” the article said further. “For example, if you buy an ETF that is 2x leveraged to the S&P 500, if the S&P rises 1% that day, you will get a return of 2%, but only for that day. The ETF resets the next day. If you are still holding it the following day, your return could be substantially different than 2x.”
Before diving in, investors need to understand if leveraged ETFs are right for them.
“Because of the risks and costs, Leveraged ETFs are typically used by day traders who want to speculate on an index and are rarely used as long term investments,” the article explained. “These same warnings apply to another class of leveraged ETFs — leveraged inverse ETFs, which try to deliver returns that are the opposite of the index’s returns. So for example, if you had an ETF that was 2x leveraged inversely to the S&P 500, if the S&P went up 1% in a day, your investment would decline 2%. The bottom line is unless you intimately understand how these ETFs are designed and can stomach the significant risk associated with them, steer clear of leveraged ETFs.”
Trading with Leverage in Tech
Tech has been a strong performer all year amid the economic mayhem caused by the pandemic. Nonetheless, social distancing measures are forcing more reliance on tech and thus, causing its outperformance in 2020.
That said, new traders interested in tech may want to give these leveraged plays a closer look. As such, here are some funds to check out:
For more news and information, visit the Leveraged & Inverse Channel.
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