Leveraged Stock ETFs: Consistent Target Ratio?
Posted:The investment objective of a GraniteShares leveraged single stock ETF is to seek, before fees and expenses, daily investment results of a multiple of the daily percentage change of an underlying stock. Such multiple is referred to as the leverage factor. For example, if a fund seeks to provide, before fees and expenses, 2 times (2X) the daily price change of stock A, the leverage factor is 2.
To achieve its leverage factor, a fund must access derivative instruments, generally swap contracts, provided by financial institutions, and rebalance the position on these instruments daily. This daily adjustment of the position can cause the fund’s actual leverage ratio factor to differ from its target for two reasons:
Execution slippage: achieving the target leverage factor requires the daily adjustment of the positions to precisely occur against the official closing price of the underlying stock. Slippage might occur due to several reasons including high volatility in the underlying stock price in the minutes preceding the close of the trading day.
Accessing Derivative Instruments: ETFs can experience large inflows, or the underlying stock can witness large price movements, both events can lead to demand for additional derivative instruments when rebalancing the fund’s positions. In the event the fund counterparties, which are generally large financial institutions, cannot provide additional derivative instruments to the fund then it might not be able to achieve its target leverage factor and may be underleveraged for a period of time until additional derivative instruments can be obtained. In an extreme scenario, if hypothetically no more derivative instruments can be sourced from the marketplace, the fund may have to lower its target leverage amount. GraniteShares works continuously to manage and or add new counterparties to its suite of ETFs to try and alleviate any derivative capacity constraints.
Monitoring a fund’s leverage factor
GraniteShares publishes on its website the following information for each of its short and leverage ETFs on daily basis:
- The Target leverage factor, and
- The Actual leverage factor, which represents a fund’s actual exposure against its underlying stock.
Comparing A and B allows shareholders to identify on any given day whether a fund achieves its target and to what extent it might be underleveraged.
