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.
A leveraged product is any instrument that multiplies the daily return of an underlying asset. The category includes leveraged ETFs, leveraged ETPs, leveraged CFDs, leveraged warrants, single-stock futures, and any margin position where the leverage is set by the broker. The role of leveraged products is to give the trader a tool for short-term tactical positioning, hedging, and capital efficiency. Outside those use cases, the products are usually a drag on long-term returns, and the drag is the result of the daily reset, the financing cost, and the gap risk.
The role in short-term tactical positioning
The clearest use case is short-term tactical positioning. A trader with a directional view on a stock, sector, or index for the next few days can use a leveraged product to size the position to the view, without committing the full notional in cash. The position is opened, held for a short period, and closed. The daily reset is not a meaningful drag over a few days, and the financing cost is small.
The tactical positioning is the most common use case, and it is where the product behaves as designed. The trader who is right produces a return that is a multiple of the underlying's return. The trader who is wrong produces a loss that is a multiple of the underlying's loss.
The tactical positioning is also where the product's mechanics align with the trader's intent. The trader is using the product for a short period, and the daily reset, the financing cost, and the gap risk are all small.
The role in hedging
A second use case is hedging. A trader with a long portfolio can take a short position in a leveraged inverse product to hedge a known risk window, and the cost of the hedge is the financing rate plus the product's tracking error. The cost is usually small for the major indices, and the hedge is a clean way to manage the risk.
The hedge is most useful in a fast market, where the trader's view on the direction is uncertain and the trader wants to protect the portfolio from a sudden drop. The hedge is also useful in a known event window (a Fed meeting, an earnings cluster), where the trader wants to lock in the portfolio's value through the event without selling the positions.
The hedge is less useful as a long-term position, because the financing cost compounds. The trader who uses a leveraged inverse product as a long-term hedge pays the financing cost for the entire hold, and the cost is a real drag. The trader who needs a long-term hedge is better off using a put option or a long-dated futures contract.
The role in capital efficiency
A third use case is capital efficiency. A trader who wants exposure to a niche sector or a high-priced stock can use a leveraged product to reach the exposure cheaply. The freed capital is the economic benefit, and the trader can use it for another trade, a hedge, or cash.
The capital efficiency is most useful for traders with small accounts, who could not otherwise afford the full notional of the position. The trader with a €5,000 account who wants exposure to a €50,000 sector ETF can use a 10:1 leveraged product, and the product is the trade. The trader with a €500,000 account who wants the same exposure is better off buying the unleveraged product, and the leverage is unnecessary.
The capital efficiency is also useful for traders who want to maintain a diversified portfolio and add a tactical position. The trader who has 90% of the account in a long-term portfolio can use the remaining 10% with 5:1 leverage to take a tactical position, and the position is sized to the trader's risk budget. The trader who uses the leverage for the full 100% of the tactical position is exposed to the asymmetric risk profile of leverage, and the risk is not consistent with the trader's risk budget.
The cost of misuse
The most common misuse is the long-term hold. A trader who buys a 2× or 3× leveraged ETF as a long-term investment is exposed to the daily reset drag, the financing cost, and the gap risk, and the result is a return that is usually below the underlying's. The trader who holds the leveraged product for a year in a choppy market produces a return well below 2× the underlying's return, sometimes negative.
The second most common misuse is the over-leveraged bet. A trader who takes a 5× leveraged position on a single stock is exposed to a 5% gap producing a 25% loss on the trader's capital, and the loss is larger than the trader's risk budget. The trader who takes the 5× leveraged position as a default, on every position, is using the leverage as a bet amplifier, and the bet amplifier is the source of the trader's losses.
The third most common misuse is the overnight hold in a high-volatility stock. A trader who holds a leveraged position in a high-volatility stock overnight is exposed to a gap at the next open, and the gap is the most common cause of large losses for retail traders using leverage. The trader who holds the position over a weekend, a holiday, or a known event is exposed to the gap, and the gap is amplified by the leverage.
How to use leveraged products correctly
The honest answer is to use the product for a short-term tactical position, with a tight stop, sized to a small percentage of the account. The trader who uses the product for a long-term hold is paying the financing cost for the entire hold period, and the cost is a real drag on the return. The trader who uses the product for an over-leveraged bet is exposed to the asymmetric risk profile, and the profile is the source of the trader's losses.
The trader who is using the product correctly is also using it for a specific purpose, with a defined exit. The trader knows when to enter, when to add, when to reduce, and when to exit. The trader is not holding it out of habit, and is not adding to it in a drawdown. The discipline is the same as for an unleveraged position, but the stakes are higher.
Related resources
Where to start
If you are evaluating a leveraged product for your strategy, the most useful features to compare are the leverage ratio, the daily reset policy, the financing cost, and the maintenance margin. Our broker comparison lists the leverage available at each broker and the regulator that supervises the account, which together tell you what the cost and the risk look like before you size the position.