This is not investment advice. The information provided is for educational and informational purposes only and does not constitute a recommendation to buy or sell any financial product.
Leveraged ETFs are exchange-traded funds that use derivatives (futures, swaps, options) to deliver a multiple of the daily return of an underlying index. A 2× leveraged ETF on the S&P 500 aims to produce a 2% return on a day the index returns 1%, and a -2% return on a day the index returns -1%. The daily reset is the defining feature, and the daily reset is the source of both the upside and the downside.
The product is designed for short-term tactical positioning, not for long-term buy-and-hold investing. The trader who uses a leveraged ETF for a day or a few days gets a return that is approximately the multiple times the index's return. The trader who holds the product for months or years gets a return that is eroded by the daily reset, the financing cost, and the gap risk.
The pros
The main advantage of a leveraged ETF is the simplicity. The trader does not need a margin account, does not need to manage the leverage, and does not need to place multiple trades. The trader buys one share of the ETF, and the ETF's manager handles the derivatives, the financing, and the daily reset. The trader's job is to choose the direction (long or inverse) and the leverage (2×, 3×).
The second advantage is the liquidity. The major leveraged ETFs (ProShares UltraPro QQQ, ProShares Ultra VIX, Direxion Daily S&P 500 Bull 3× Shares) have high trading volume, tight spreads, and a liquid options market. The trader can enter and exit the position easily, and the trader can use the options market for additional strategies.
The third advantage is the diversification. The leveraged ETF tracks a broad index (the S&P 500, the Nasdaq 100, the Dow Jones, a sector index), and the trader gets the diversification of the index with the leverage of the product. The trader is not taking a concentrated bet on a single stock.
The fourth advantage is the cost transparency. The expense ratio of a leveraged ETF is disclosed in the prospectus (typically 0.75-1.5% per year), and the financing cost is built into the daily return. The trader knows the cost structure upfront, and the trader can compare the cost across products.
The cons
The first disadvantage is the daily reset drag. The daily reset means that the product's return over a multi-day period is not the simple multiple of the index's return. In a choppy market with no net movement, the leveraged ETF loses value because of the daily reset. A 2× leveraged ETF in a market that goes up 1% on Monday and down 1% on Tuesday produces a -0.02% return over the two days (not the 0% return of the index), and the loss compounds over time.
The daily reset drag is the most common reason that inexperienced traders lose money in leveraged ETFs. The trader who buys the product for a long-term hold in a volatile market produces a return well below the index's return, and the trader is surprised by the result.
The second disadvantage is the financing cost. The leveraged ETF uses derivatives that have a financing cost, and the cost is built into the daily return. The cost is typically 1-2% per year on a 2× leveraged ETF and 2-3% per year on a 3× leveraged ETF. The cost is charged every day, and the cost is a real drag on the return over a multi-week hold.
The third disadvantage is the gap risk. The leveraged ETF is priced at the close, and the gap at the next open is reflected in the ETF's price. A 3% gap down on the index produces a 6% loss on a 2× leveraged ETF and a 9% loss on a 3× leveraged ETF. The gap risk is most acute over a weekend, a holiday, or a known event.
The fourth disadvantage is the limited product range. Leveraged ETFs are available only for the major indices and some sectors. A trader who wants a leveraged position on a specific stock or a small-cap index cannot use a leveraged ETF.
When to use leveraged ETFs
The honest answer is to use a leveraged ETF for a short-term tactical position (1-5 days), with a clear exit and a tight stop. The product is also useful as a hedge for a portfolio position, where the hedge is for a specific risk window (an earnings season, a Fed meeting). The product is not useful for a long-term buy-and-hold position.
Common questions about leveraged ETFs
Is a 3× leveraged ETF riskier than a 2×? Yes. A 3× leveraged ETF is three times as sensitive to the index's daily move, and the daily reset drag is larger. A 3× ETF loses more value in a choppy market and needs a larger index move to break even.
Can I use a leveraged ETF for a sector bet? Yes, there are leveraged ETFs for major sectors (technology, financials, energy, healthcare, biotechnology). The sector ETFs have the same daily reset and the same risks as the broad index ETFs.
Are leveraged ETFs regulated? Yes, leveraged ETFs are regulated by the SEC in the US and by the relevant authority in other jurisdictions. The ETF provider must disclose the expense ratio, the leverage ratio, and the daily reset policy in the prospectus.
Related resources
Where to start
If you are evaluating leveraged ETFs, the most useful features to compare are the leverage ratio, the expense ratio, the daily reset policy, and the index tracked. Our broker comparison lists the leveraged ETFs available at each broker and the expense ratios, which together tell you what the product looks like before you buy.