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Over the past few years there has been an emergence of many leveraged and inverse ETFs/ETNs that track various assets as well as complex ETF/ETN products (which are often leveraged or inverse leveraged as well) that track the VIX.

From the start I will say the majority of these trading instruments are designed to track gains or losses in their underlying for one day.

First some education on the way gains and losses are tracked in the stock market.

Gains and losses are tracked via a lognormal scale in which there are logarithmic gains, and normal losses. An example of this would be for you to buy XYZ at $50 in which it then goes to $100 you made a 100% profit. If instead you short XYZ at $100 and it goes to $50 you made a 50% profit. This would be considered common knowledge.

Inverting or leveraging such gains or losses will not accurately track the underlying given a period of time longer than one day. If a 3x leveraged ETFs underlying went in a straight line, the 3x leveraged ETF itself would perform with greater than 300% returns over a period of time longer than one day because of the daily rebalancing. However markets do not move in a straight line and therefore volatility destroys these funds. For an example, on why this is true, look at the tables below that use imaginary price movements.


XYZ is the underlying and ZYX tracks the underlying percentage gains by inverting them.


XYZDaily Percent Gain/LossZYXDaily Percent Gain/Loss
$10 $10

Total Percent Gain/Loss XYZ = -20%

Total Percent Gain/Loss ZYX = -29.1%

(These results are only for buy/hold strategies, not enter/exit/enter.)

XYZ is the underlying and 2XYZ tracks the underlying percentage gains by doubling them.


XYZDaily Percent Gain/Loss2XYZDaily Percent Gain/Loss
$50 $50
$60+20%$70+40 %
$48-20 %$42-40 %
$57.60+20 %$58.80+40 %
$46.08-20 %$35.40-40 %
$55.30+20 %$49.56+40 %
$44.24-20 %$29.74-40 %
$53.08+20 %$41.63+40 %
$42.47-20 %$24.98-40 %
$50.96+20 %$34.97+40 %
$40.77-20 %$20.98-40 %
$48.92+20 %$29.37+40 %

Total Percent Gain/Loss XYZ = -2.16%

Total Percent Gain/Loss 2XYZ = -41.26%

XYZ is the underlying and 2ZYX tracks the underlying by doubling and inverting the percentage movements.


XYZDaily Percent Gain/Loss2ZYXDaily Percent Gain/Loss
$50 $50

Total Percent Gain/Loss XYZ = -2.16%

Total Percent Gain/Loss 2ZYX = -82.14%

XYZ is the underlying and 3ZYX tracks the underlying percentage gains by tripling and inverting the percentage movements.


XYZDaily Percent Gain/Loss3ZYXDaily Percent Gain/Loss
$50 $50

Total Percent Gain/Loss XYZ = -2.16%

Total Percent Gain/Loss 3ZYX = -95.7%

For this reason, all inverse or leveraged ETFs will, given a long enough timeframe, go to zero.

Below are some real-life examples of these instruments underperforming:

FAS(3x) vs $RIFIN

FAZ(3x Inverse) vs $RIFIN

SOXL(3x) vs $SOX

SOXS(3x Inverse) vs $SOX

TNA(3x) vs $RUT

TZA(3x Inverse) vs $RUT

SPXL(3x) vs $SPX

SPXS(3x Inverse) vs $SPX

TVIX(2x) vs $VIX

The SEC itself has a warning on its website about the dangers of these instruments.

A 'Safe' Trade?

So, finally, what's this 'safe' trade?

A shrewd trader would short two opposite funds (3x and 3x Inverse) at the same time thereby only collecting the decay profit, whilst at the same time maintaining essentially zero market exposure. A more aggressive strategy would be to short one of these funds if you are bullish on their opposite fund, thereby being a safer trade than buying the one you are bullish on because shorting one will let you be working with the decay and not against it.

Remember that the act of shorting itself does carry significant risk if you do not have a lot of extra cash, and as such you should monitor the trades you make. If a trend with very little volatility starts, you could find yourself on a margin call (take a look at FAZ in 2008). Considering trends do not last forever (or at least they haven't for the past 100 years) the instrument should in theory after an amount of time fall back to Earth and eventually go to zero in a secular bear market, even if it does go against you at first. You should have a significant amount of extra cash available while shorting so you do not find yourself on margin call.

You may find it hard to acquire shares to short. In such a case you could choose to play with options. That's another ballgame, though, and as such I will not be writing about options strategies for trading these instruments.


In a secular bull market do not short leveraged bullish ETFs. Volatility is what destroys these funds. In a secular bull market there is very little volatility. I would say it's OK to short bullish ETFs in a cyclical bull market within a secular bear however.

It's also important to understand that leveraged/inverse ETN funds carry more risk than an ETF. The reason being is because the entity in charge of the ETN may suspend share creation causing the ETN to trade at a premium to its NAV (Net Asset Value). This happened a few months ago with TVIX and when share creation resumed the instrument went cliff diving.

Also, on volatility products. Volatility products have additional factors at play in determining their values, these factors being contango and backwardation. The VIX futures are more frequently in contango then they are in backwardation. Contango causes ETFs that are bullish on VIX to decay and Backwardation does the opposite. Therefore, vehicles like TVIX will decay even faster. (For a more in-depth explanation on Contango and Backwardation here is an article that explains it rather well.)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.