馃攳
What Are Leveraged and Inverse ETFs and ETNs & How Do They Work? - YouTube
Channel: TD Ameritrade
[1]
Leveraged and inverse ETFs and ETNs are types
of ETPs, or exchanged-traded products, that
[8]
seek to provide a multiple and/or the opposite
performance of a certain index or benchmark.
[14]
For example, an investor might buy a leveraged
ETP in an attempt to potentially boost returns
[21]
on a stock index they think will go up or
an inverse ETP in an attempt to provide a
[27]
short-term hedge to their portfolios if they
anticipate a falling market.
[33]
While the concept may sound simple, leveraged
and inverse ETPs are complex and are subject
[39]
to significant risks.
[41]
Before using these products, investors should
understand what they鈥檙e designed to do,
[46]
what risks they carry, and that these products
are not suitable for most investors.
[52]
Let鈥檚 start with leveraged ETPs.
[55]
Leveraged ETPs seek to provide double, triple,
or quadruple the returns of an underlying
[61]
index for one day.
[63]
The amount of leverage is commonly indicated
by their names, which often include terms
[67]
like 2x, 3x, 4x, or ultra.
[72]
These ETPs primarily provide the leverage
needed by entering into an agreement called
[77]
a swap with large investment banks but
may also use futures and options contracts
[82]
traded on a particular stock index they want
to emulate.
[86]
For example, let鈥檚 say we have a leveraged
ETP that seeks to produce twice the returns
[92]
of a stock index鈥檚 daily performance.
[94]
For easy math, we鈥檒l say that the ETP is
trading at $100 per share and the underlying
[101]
index is at 10,000.
[103]
If the index rises 10% to 11,000, shares of
the ETP will theoretically rise about 20%
[111]
from $100 to $120 for a gain of $20 per share.
[117]
Note, it is the two times leverage factor
that provides this extra return.
[123]
However, if the index falls back to 10,000,
or 9.09%, the ETP will likely fall twice as
[131]
much, or 18.18%, pushing the price down to
$98.18 per share for a loss of almost $22
[140]
per share.
[141]
As you can see, the leverage led to large
gains and then large losses, and the ETP ended
[147]
up lower than the starting price even though
the index ended where it started.
[153]
Now let鈥檚 look at inverse ETPs.
[157]
Inverse ETPs seek to provide returns opposite
of the underlying index.
[162]
The names of these products may include terms
like short or bearish.
[166]
Here鈥檚 an example of how this works.
[168]
We鈥檒l assume the ETP is trading at $100
per share and the underlying index is at 10,000.
[176]
If the index falls 3%, or 300 points, to 9,700,
the ETP should rise 3% to $103 per share.
[186]
If the index rises 3%, the ETP should fall
3% to $97 per share.
[194]
Additionally, inverse ETPs may also be leveraged
ETPs, magnifying the potential gains and losses.
[202]
It鈥檚 important to realize that leveraged
and inverse ETPs are only designed to achieve
[208]
this performance over a fixed period, typically
a day.
[212]
This means that unlike more traditional ETPs,
leveraged and inverse ETPs are not designed
[219]
to be held overnight or used as long-term
buy-and-hold investments.
[224]
One reason for this is that at the end of
the trading session, these ETPs reset
[230]
their investment strategies in order to maintain
their leverage ratio.
[234]
For example, if the index goes up in value,
the ETP will have to increase its exposure
[240]
to the index for the next day in order to
get the right multiple.
[245]
Resetting can result in a difference in the
returns of the ETP compared to the underlying
[249]
index.
[251]
The resetting difference could compound losses
or even cause losses despite the underlying
[256]
index moving in the desired direction, especially
in volatile markets.
[261]
Furthermore, in lightly traded markets (such
as VIX futures), the resetting of leverage
[266]
and inverse ETPs has itself contributed to
increased volatility.
[271]
Another way that price volatility can lead
to losses is if major movements in the underlying
[277]
index are so extreme that the losses result
in the leveraged ETP falling below a fund鈥檚
[283]
preset minimum value.
[285]
If this happens, the leveraged ETPs may be
forced to close.
[289]
Fund closures can lead to major losses for
investors.
[293]
Closure can be particularly complex for ETNs,
which are structured differently than ETFs.
[299]
While it may feel a bit like alphabet soup,
it鈥檚 important to understand how ETNs are
[304]
created and how market volatility could lead
to an ETN being closed.
[310]
Unlike an ETF, which provides ownership in
a basket of securities, an ETN is actually
[316]
a debt instrument issued by a financial institution
and structured more like a bond.
[322]
Instead of interest payments, the ETN promises
returns linked to an underlying index over
[327]
a certain period of time and to return the
principal at maturity, usually 20 to 30 years
[334]
out.
[335]
This structure allows ETNs to very closely
track the performance of their underlying
[339]
index but also comes with additional risks.
[343]
First is credit risk.
[345]
If the financial institution issuing the ETN
fails, investors may only be entitled to receive
[351]
pennies on the dollar or lose their entire
investment.
[354]
There鈥檚 also closure risk.
[357]
Some ETNs may be called before maturity.
[361]
The process of calling the note is known as
an accelerated redemption, which allows
[366]
the issuer to close the ETN and return the
value of the note, if any, to investors after
[372]
a certain date.
[373]
If the value of the note has dropped, investors
can experience losses.
[378]
However, not all ETNs allow accelerated redemption.
[383]
Instead, market conditions may force the issuers
to delist ETNs from a national exchange, making
[390]
it difficult for investors to liquidate their
position.
[394]
Investors may be forced to either wait for
the note鈥檚 scheduled maturity, which could
[398]
be decades away, or try to sell their shares
in the over-the-counter market, likely at
[403]
a substantial loss.
[405]
So, with these risks in mind, what should
you do if you want to trade a leveraged or
[410]
inverse ETP?
[412]
First, make sure you understand the product
and its goals and check to see if it meets
[417]
your objectives and risk tolerance.
[419]
Also, familiarize yourself with the ETP鈥檚
call features and maturities, and its costs
[425]
and fees.
[427]
All of this can be found in the prospectus
and the pricing supplement, which also contains
[431]
a history of whether the ETP has traded at
a premium or a discount to its underlying
[436]
net asset value.
[438]
You should also check the product鈥檚 bid-ask
spread because wider spreads could make it
[442]
difficult to get a trade filled at your desired
price.
[446]
If you鈥檙e investing in a taxable account,
you may want to review the product鈥檚 history
[450]
of distributing capital gains.
[453]
Although ETFs are usually tax-efficient, certain
strategies may result in a higher tax burden
[458]
than other types of ETFs.
[460]
Be sure to contact a qualified tax advisor
about your particular circumstances.
[465]
Next, check with your broker to see what rules
they have around trading leveraged and inverse
[470]
ETFs and ETNs.
[473]
Some brokerages will require you to sign an
agreement acknowledging the risks.
[478]
Finally, determine your entry and exit strategies
before placing the trade.
[483]
Have a plan for what you would do if the trade
goes badly to avoid large losses.
[487]
Remember, if you do decide to hold a leveraged
ETP longer than a day, you may not get the
[493]
returns you expected.
[495]
You may even experience a loss despite the
underlying index moving in a favorable direction.
[502]
Leveraged and inverse ETPs are complex products
that require caution.
[506]
Take time to familiarize yourself with the
benefits and risks of these investments.
Most Recent Videos:
You can go back to the homepage right here: Homepage