Reverse Splits: Why Leveraged ETFs All Go to Zero

Includes: DRV, ERY, TECS, TZA
by: Everyday Finance

I couldn’t help but notice the press release yesterday on the reverse splits announced for 4 more leveraged ETFs:

  • Direxion Daily Energy Bear 3x Shares (NYSEARCA:ERY)
  • Direxion Daily Real Estate Bear 3x Shares (NYSEARCA:DRV)
  • Direxion Daily Small Cap Bear 3x Shares (NYSEARCA:TZA)
  • Direxion Daily Technology Bear 3x Shares (TYP)

Some Details on the Reverse Splits:

  • These splits will occur for all shareholders of record after the market closes on July 7.
  • They will undergo 5:1 reverse splits, thus increasing the share price by 5X and decreasing the number of shares held by 5.
  • No transaction fees are assessed when such a transaction occurs.
  • If there are fractional shares, you’ll have the cash proceeds delivered via cash to your trading account.

This has become somewhat of a routine occurrence. I got an email from one reader a while back rejoicing over how much his ETF had risen in value since he last checked recently only to be informed that this was due to a reverse split and he now owned fewer shares. Whoops. But this is all too common; sometimes, charting results on financial websites can’t even keep up with all these reverse splits on leveraged ETFs.

For the uninitiated, leveraged ETFs offer 2X or even 3X the DAILY return of a particular sector or index. I emphasize “daily” because over time, it is a mathematical certainty that unless there is a pure sustained trend in one direction for an infinite period of time (what comes up must come down), the value of your holdings will decrease over time due to leveraged ETF daily rebalancing (see article for much more detailed explanation and numerical example).

Admittedly, in some circumstances, I’ve employed leveraged ETFs to jump on a trend as a TRADE, not an investment, like when the Euro was imploding, utilizing EUO to short the Euro on a 2x basis (position closed for a small gain). However, I never, ever recommend blindly holding any leveraged ETF given the eventual demise in share price.

All you have to do is look at the evidence:

  • Past history – just view a long/short combo in Google Finance over a multi-month period and in many cases, they’ve actually BOTH lost money
  • Continued Reverse Split Announcements
  • Warnings on the prospectus themselves

Despite the warnings and even new margin requirements (which really only made it more costly for traders, but likely won’t deter retail investors from using them), new investors that don’t fully understand this phenomena continue to pile into these instruments. There is so much demand chasing supercharged returns that 16 New Leveraged ETFs just launched earlier this year.

Disclosure: Currently engaged in various short pairs trades with leveraged ETFs but no net long position in any leveraged ETF. My current portfolio can be viewed for reference which is updated monthly.