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 ). This also applies to the short ETFs with a lower leverage in cases of high volatility of the underlying index. ...

However, the price of ETFs cannot drop below 0. So, even though you're invested with borrowed money, you cannot lose more than your initial investment (before brokerage fees and trading costs, of course). Additionally, most equity investors use leverage when they invest—whether they know it or not.

It is also important to note that leverage also means it is possible that a leveraged inverse ETF can go to zero or near zero with a large enough daily move in the price of the underlying asset or index. However, this is very unlikely due to the scale of the price move required.

Bottom Line on Leveraged ETFs

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.

Yes, an inverse ETF can reach zero, particularly over long periods. Market volatility, compounding effects, and fund management concerns can exacerbate losses. To successfully manage possible risks, investors should be aware of the short-term nature of these securities and carefully monitor their holdings.

Yup, you read that right. Now, the 10-year return for those who stayed invested in the SQQQ isn't as bad. It's only 99.94%. But you get my drift – eventually, this fund trends toward zero, as the stock market continues to make new highs over the very long-term.

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.

Compounding Risk

Since an inverse ETF has a single-day investment objective of providing investment results that are one times the inverse of its underlying index, the fund's performance likely differs from its investment objective for periods greater than one day.

Inverse ETFs have a one-day holding period. If an investor wants to hold the inverse ETF for longer than one day, the inverse ETF must undergo an almost daily operation called rebalancing. Inverse ETFs can be used to hedge a portfolio against market declines.

What is a leveraged inverse ETF? It is also possible to combine these two types of ETFs, creating a leveraged inverse ETF. This type of ETF, also called "ultra-short" ETFs, is designed to magnify the inverse of an index's performance.

Why not invest in 3x leveraged ETF? ›

A leveraged ETF uses derivative contracts to magnify the daily gains of an index or benchmark. These funds can offer high returns, but they also come with high risks and expenses. Funds that offer 3x leverage are particularly risky because they require higher leverage to achieve their returns.

The daily rebalancing of leveraged and inverse ETFs creates a situation that for periods longer than a day or two the return of a leveraged or inverse ETF will deviate from the margin account benchmark.

Leveraged ETFs are risky investments. The two major risks associated with leveraged ETFs are decay and high volatility. High volatility translates to high risk.

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 ). This also applies to the short ETFs with a lower leverage in cases of high volatility of the underlying index. ...

But can a leveraged ETF go negative? No. If you own a leveraged ETF you can't lose more than your initial investment amount.

"Leveraged and inverse funds generally aren't meant to be held for longer than a day, and some types of leveraged and inverse ETFs tend to lose the majority of their value over time," Doak explained.

In other words, you could potentially be liable for more than you invested because you bought the position on leverage. But can a leveraged ETF go negative? No. If you own a leveraged ETF you can't lose more than your initial investment amount.

Most leveraged and inverse ETFs reset each day, which means they are designed to achieve their stated objective on a daily basis. With the effects of compounding, over longer timeframes the results can differ significantly from their objective.

No. The most an investor can lose in a Leverage Shares ETP is the entire value of their initial investment plus any reinvested dividends.