What the Heck are Leveraged ETFs?

The following post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga.

Most investors know what stocks and bonds are and how they generally work. But, when someone starts talking about garden-variety exchange-traded funds (ETFs) and short-selling, they may sound quite smart at parties. What about chiming in with the Direxion Daily S&P 500® High Beta Bull (HIBL) and Bear (HIBS) 3X Shares Leveraged ETFs?  That’s a mouthful. And if you’re just an everyday investor, it may be more than you can handle. These are only for risk lovers.

Leveraging is not for low-risk investors, but with the rise of commission-free trading platforms, many retail investors have put more time and effort into their strategies and many have even started turning into traders. But leverage, once used primarily for Wall Street guys, is something that retail traders have started to embrace.  

In the literal sense, leverage is the extra force that is able to be exerted upon an object using the positioning or relative orientation of another object. In the financial sense, it’s theoretically not too different. Think about it like applying an investment crowbar to some specific index but certainly with some important caveats. There is a different level of conceptual and actionable complexity to leveraged ETFs than a number of other investment tools.

Seeing “3x leverage” on an ETF means that the goal of the ETF is to give the buyer exposure to change that is 3 times the amount that one would have from simply owning the underlying asset. Adding “daily” to this means that this ETF is meant to rebalance and go again every day, and is not meant for long-term investing — and this is just the start.

Learning From the Pros

If terms such as beta slippage and volatility decay don’t sound familiar, it’s important to learn and understand more before trading with leverage. A great resource for understanding the more in-depth and crucial details of leveraged ETFs can be straight from the source, like ETF company Direxion, which operates a significant number of leveraged and inverse ETFs. It understands the complexity of the subject and some of the trepidation from traders, and so it made an “ETF University” to help educate traders on the ins and outs of the subject. Some of its easiest and most user-friendly content is the aptly named Understanding Leveraged & Inverse ETFs page. 

There are some really good reasons why traders use leveraged ETFs in their strategies. To a certain extent, it boils down to the possibility of larger gains than normal without having to resort to other tactics like margin trading and other more complicated derivatives — but stay tuned for our next article on this subject and we’ll dive right into it! 

For more in-depth explanations of technical terms. what they mean, and how they can affect you, check out the explainer page.

Terms leveraged ETF investors should know:

Beta - A measure of the systematic variability of a security or a portfolio in relation to a target index. A beta of more than 1.00 indicates that the security or portfolio would have higher volatility than the index; a beta of less than 1.00 indicates lower volatility.

Counterparty - In financial service terms, counterparty can refer to brokers, investment banks, and other securities dealers that serve as the contracting party when completing “over-the-counter” securities transactions. The term is generally used in this context in relation to “counterparty risk,” which is the risk of monetary loss a firm may be exposed to if the counterparty to an over-the-counter securities trade encounters difficulty meeting its obligations under the terms of the transaction.

Futures Contract - A contract, traded on a futures exchange, to buy or sell a standardized quantity of a specified commodity of standardized quality (e.g., a “basket” of corporate equities [“stock indices”] at a certain date in the future, at a price (the futures price) determined by the market price at the time of the purchase or sale of the contract.

INAV (the Intraday NAV) - Used as a reference for an ETF’s underlying value during trading hours, prior to market close. In many cases, the ETF will trade at a premium or discount to the NAV due to various factors, including supply and demand. Calculating INAV prior to purchasing an ETF allows you to determine whether you are purchasing it at a premium or a discount to the ETF’s NAV.

Secondary Market - The financial market for trading of securities that have already been issued in an initial private or public offering. New ETF shares are created in the primary market in large lots called creation units by financial professionals called Authorized Participants. Once these shares are created, they become available for purchase to all investors in the secondary market.

Swap - A derivative in which two counterparties agree to exchange one stream of cash flows for another stream. These streams are called the legs of the swap.

The cash flows are calculated over a notional principal amount, which is usually not exchanged between counterparties. Consequently, swaps can be used to create unfunded exposures to an underlying asset, since counterparties can earn the profit or loss from movements in price without having to post the notional amount in cash or collateral.

An investor should carefully consider a Fund’s investment objective, risks, charges, and expenses before investing. A Fund’s prospectus and summary prospectus contain this and other information about the Direxion Shares. To obtain a Fund’s prospectus and summary prospectus call 646-760-3323 or click here. A Fund’s prospectus and summary prospectus should be read carefully before investing.

Investing in a Direxion Shares ETF may be more volatile than investing in broadly diversified funds. The use of leverage by a Fund increases the risk to the Fund. The Direxion Shares ETFs are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk, consequences of seeking daily leveraged, or daily inverse leveraged, investment results and intend to actively monitor and manage their investment.

Direxion Shares Risks - An investment in the ETFs involves risk, including the possible loss of principal. The ETFs are non-diversified and include risks associated with concentration that results from an ETF’s investments in a particular industry or sector which can increase 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. The ETFs do not attempt to, and should not be expected to, provide returns that are a multiple of the return of their respective index for periods other than a single day. For other risks including leverage, correlation, daily compounding, market volatility and risks specific to an industry or sector, please read the prospectus.

Distributor for Direxion Shares: Foreside Fund Services, LLC.

The preceding post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga. Although the piece is not and should not be construed as editorial content, the sponsored content team works to ensure that any and all information contained within is true and accurate to the best of their knowledge and research. This content is for informational purposes only and not intended to be investing advice.