Leveraged and Inverse ETFs Explained
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Exchange-traded funds (ETFs) have become popular as convenient ways to invest in various assets. They are often collections of stocks, bonds, indexes, commodities, or sectors.
On top of that, some experienced investors look to more advanced tools like leveraged and inverse ETFs for potential amplified returns.
In the sections below, we’ll explain leveraged and inverse ETFs, how they work, and the risks, challenges, and strategies associated with these investments.
What is a Leveraged ETF?
A leveraged ETF is a fund designed to amplify the returns of an index, commodity, or single stock. For instance, a 2x leveraged ETF aims to return twice the daily performance of the asset it is tied to.
For example, let’s use the GraniteShares 2x Long NVDA Daily ETF (ticker: NVDL). This leveraged ETF will return twice the daily performance of the single stock NVDA. Hypothetically speaking, if NVDA rises by 1%, the leveraged ETF rises by 2%. If NVDA drops by 1%, the leveraged ETF falls by 2%.
The leveraged ETF is reset daily to maintain the leverage ratio, so the overall performance can differ from the multiple over longer periods.
Experienced traders commonly use leveraged ETFs with medium-to-high risk tolerance to capitalize on short-term market movements.
What is an Inverse ETF?
An inverse ETF works similarly to the leveraged ETF mentioned above; however, inverse ETFs move in the opposite direction of the asset they are tied to. So when the index or stock moves up, the inverse ETF moves down and vice versa.
The main purpose of an inverse ETF is for investors to profit from a decline in the value of the underlying stock, index, or asset. These funds are sometimes called “short ETFs” or “bear ETFs.”
Let’s use the GraniteShares 2x Short NVDA Daily ETF (ticker: NVD) as an example of an inverse ETF. If the single stock of NVDA drops by 1%, the inverse ETF would rise by 2%. If NVDA rises by 1%, the inverse ETF falls by 2%.
These inverse ETFs also rebalance daily, as mentioned above with the leveraged ETFs.
- Definition and purpose
- How inverse ETFs work
Types of Leveraged and Inverse ETFs
In the examples above, we used NVDA to show how leveraged and inverse ETFs work. There are plenty of other instances of these ETFs, whether tied to a single stock, index, sector, or commodity.
Single Stock Leveraged ETFs
Here’s a list of popular leveraged ETFs tied to a single stock, such as Apple, Coinbase, Tesla, Microsoft, Amazon, and more:
- AMZZ: GraniteShares 2x Long AMZ Daily ETF
- BABX: GraniteShares 2x Long BABA Daily ETF
- AAPB: GraniteShares 2x Long AAPL Daily ETF
- CONL: GraniteShares 2x Long COIN Daily ETF
- FBL: GraniteShares 2x Long META Daily ETF
- MSFL: GraniteShares 2x Long MSFT Daily ETF
- NVDL: GraniteShares 2x Long NVDA Daily ETF
- TSLR: GraniteShares 2x Long TSLA Daily ETF
- TSL: GraniteShares 1.25x Long TSLA Daily ETF
Single Stock Inverse ETFs
The following is a list of inverse ETFs (or short ETFs) tied to a single stock:
- NVD: GraniteShares 2x Short NVDA Daily ETF
- TSDD: GraniteShares 2x Short TSLA Daily ETF
- AMDS: GraniteShares 1x Short AMD Daily ETF
Other Leveraged & Inverse ETFs
Other leveraged and inverse ETFs on the market are tied to a specific sector, index, or commodity.
- Index: Daily multiplier tied to S&P 500, Dow Jones, and more.
- Commodity: Leverage associated with underlying commodities like oil, gold, silver, grain, etc.
- Sector: Tying a leveraged ETF to the broad performance of a sector like technology, energy, banking, or others.
Benefits of Leveraged and Inverse ETFs
Leveraged and inverse ETFs have several potential benefits. They can be helpful tools to enhance returns depending on your investment strategy, risk tolerance, and overall investment style.
Potential for Amplified Returns
Leveraged ETFs can help you capture higher returns in a shorter timeframe to take advantage of a short-term move by the underlying asset. Different multipliers depend on the fund, commonly up to 2x, but in some situations, less leverage is used at 1.25x.
Opportunities in Both Rising and Falling Markets
Inverse ETFs gain value when the underlying asset declines. This provides opportunities for profit and different strategies even in bear markets. It also allows you to hedge against downturns without short-selling individual stocks.
Accessibility and Convenience
These leveraged and inverse ETFs trade on major exchanges and brokerages like regular ETFs, making them accessible and easy to buy and sell during market hours. They are a simple way to gain the desired exposure rather than trading options or futures.
Risks and Challenges
Leveraged and inverse ETFs come with significant risks. Because of this, these investments may not make sense for inexperienced investors, those with a low-risk tolerance, or long-term investors looking to buy and hold for years to come.
Market Volatility
These leveraged long and short ETFs can experience fast, substantial swings in value due to their structure. If the market (or single stock) moves sharply, the value of these ETFs could change drastically due to their multiplying effect.
Daily Rebalancing and Decay
Gains and losses are compounded daily. As mentioned, the leveraged ETF is reset daily to align with the underlying asset. Because of this, a series of bad days can lead to significant losses even if the underlying asset is somewhat stable over time.
Investment Strategies
There are times when investing in leveraged ETFs makes sense, and other strategies present opportunities to invest in inverse ETFs as part of a larger plan. Either way, it’s best if you are an experienced trader with an understanding (and strategy) of these investment types.
When to Use Leveraged ETFs
- Short-term trading: These ETFs are better suited for taking advantage of short-term changes in the market, which can last from a day or two to perhaps a week or two.
- Bullish outlook: If you expect a sharp uptick in the market or underlying asset.
When to Use Inverse ETFs
- Expected downturn: If you expect a bearish downturn in the market or underlying asset, inverse ETFs offer a way to profit from the expected decline.
- Hedging: Inverse ETFs can be a valuable tool for hedging to offset potential losses from unfavorable market conditions in an existing portfolio.
Risk Management Techniques
There are a few ways you can limit your risk and protect yourself from large, unexpected losses when investing in leveraged and inverse ETFs, such as the following:
- Limit orders: Controlling entry and exit points to reduce risk and remove emotions from decisions.
- Stop-loss orders: Protects against significant, unexpected losses by automatically triggering a sale at a predetermined point.
- Diversification: Using leveraged and inverse ETFs as part of a larger investment plan with diversification.
Conclusion
Leveraged and inverse ETFs are investment tools designed to amplify market gains or losses associated with an underlying asset, stock, or index.
They are more suitable for short-term strategies for experienced investors with medium-to-high risk tolerance. Potential buyers should carefully consider their risk tolerance and timeframe when considering these ETFs.
ETFs by GraniteShares
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Important Information
Investors should consider the investment objectives, risks, charges and expenses carefully before investing. For a prospectus or summary prospectus with this and other information about the Funds, please call (844) 476 8747 or visit www.graniteshares.com. Read the prospectus or summary prospectus carefully before investing.
The investment program of the funds is speculative, entails substantial risks and include asset classes and investment techniques not employed by more traditional mutual funds.
PRINCIPAL FUND RISKS (see the Prospectus for more information)
The Fund is not suitable for all investors. The investment program of the funds is speculative, entails substantial risks and includes asset classes and investment techniques not employed by most other ETFs and mutual funds. Investments in the ETFs are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Fund is designed to be utilized only by knowledgeable investors who understand the potential consequences of seeking daily leveraged (2X) investment results, understand the risks associated with the use of leveraged exposure and are willing to monitor their portfolios frequently. For periods longer than a single day, the Fund will lose money if the Underlying Stock’s performance is flat, and it is possible that the Fund will lose money even if the Underlying Stock’s performance leveraged over a period longer than a single day. An investor could lose the full principal value of his/her investment within a single day.
The Fund seeks daily leveraged investment results and are intended to be used as short-term trading vehicles. This Fund attempts to provide daily investment results that correspond to the respective leveraged of the performance of its underlying stock (a leveraged Fund).
Investors should note that the fund pursues daily leveraged investment objectives, which means that the fund is riskier than alternatives that do not use leverage because the fund magnifies the performance of their underlying security. The volatility of the underlying security may affect a Fund’s return as much as, or more than, the return of the underlying security.
Because of daily rebalancing and the compounding of each day’s return over time, the return of the Fund for periods longer than a single day will be the result of each day’s returns compounded over the period, which will very likely differ from 200% of the return of the Underlying Stock over the same period. The Fund will lose money if the Underlying Stock’s performance is flat over time, and as a result of daily rebalancing, the Underlying Stock volatility and the effects of compounding, it is even possible that the Fund will lose money over time while the Underlying Stock's performance increases over a period longer than a single day.
An investment in the Fund involves risk, including the possible loss of principal. The Fund is non-diversified and includes risks associated with the Fund concentrating its investments in a particular industry, sector, or geographic region which can result in increased volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. Risks of the Fund include effects of Compounding and Market Volatility Risk, Inverse Risk, Market Risk, Counterparty Risk, Rebalancing Risk, Intra-Day Investment Risk, Daily Index Correlation Risk, Other Investment Companies (including ETFs) Risk, and risks specific to the securities of the Underlying Stock and the sector in which it operates. These and other risks can be found in the prospectus.
This information is not an offer to sell or a solicitation of an offer to buy shares of any Funds to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction.
THE FUNDS AREDISTRIBUTED BY ALPS DISTRIBIUTORS, INC. GRANITESHRES IS NOT AFFILIATED WITH ALPS DISTRIBUTORS, INC
